S&P 500 falls for third straight week despite favorable jobs data

The secret recipe for success in the stock market is simple: 30% in market analysis skills, 30% in risk management, 30% in emotion control and 10% in luck. – Benjamin Lee 

The stock market began the month of September on an inauspicious note after release of the August employment report and all three major stock averages posted losses for the week. The S&P 500 Index closed lower for the third consecutive week with a loss of 3.3% while the technology-heavy Nasdaq Composite Index dropped 4.2% as higher interest rates took their toll on high-priced growth stocks. After a promising first half performance in the month of August which saw the S&P 500 rally on the expectation that inflation had peaked, the benchmark index reversed course and relinquished those gains in the second half as the Federal Reserve reiterated its commitment to bring down inflation by tightening monetary policy further. Friday’s release of the August employment report initially was viewed favorably by investors as 315,000 new jobs were added, slightly more than expected but far less than the 528,000 jobs that were created in July. The unemployment rate also edged higher to 3.7% from 3.5% and wages grew less than forecast, suggesting to investors that the Federal Reserve might not be as aggressive in hiking interest rates. While the stock market rose after the report was released, the gains turned to losses as the realization set in that wage growth was still high and that the job numbers, though far fewer than in July, were still considered strong. For this reason, the expectation for a 75-basis point (a basis point is one hundredth of one percent) is once again more likely when the Fed meets later this month. Bond yields also reflected this thinking as the 2-year Treasury yield rose to 3.40%, its highest level since November 2007, while the 10-year Treasury yield jumped to 3.19%. Higher interest rates are definitely a headwind for stocks, but as the second quarter earnings season winds down, S&P 500 companies are on track to post profit growth of nearly 9% despite a slowing economy, high inflation, ongoing global supply chain disruptions and a surging U.S. dollar.

Last Week

Other jobs-related data last week was mixed as ADP reported private payrolls in August grew by only 132,000, down from 270,000 in July and below estimates of 300,000, while weekly jobless claims fell to 232,000, a decline of 5,000 from the previous week and lower than expected. The Job Openings and Labor Turnover Survey (JOLTs) showed that there were 11.24 million job openings in July, much higher than expected and nearly double the number of available workers of 5.67 million, a sign that is inflationary as employers are forced to offer higher wages to attract workers. The S&P CoreLogic Case-Shiller Index showed that home prices were nearly 20% higher in June than during the same month last year while another report showed that home prices declined 1% from June to July, the first monthly decline in almost three years. The consumer confidence index in August was much higher than in July and was the first gain in four months.

For the week, the Dow Jones Industrial Average declined 3.0% to close at 31,318 while the S&P 500 Index fell 3.3% to close at 3,924. The Nasdaq Composite Index dropped 4.2% to close at 11,630.

This Week

The ISM services sector Purchasing Manager’s Index (PMI) for August is expected to be lower than in July but still above the expansionary level of 50. The Federal Reserve releases its Beige Book, which summarizes the current economic conditions of the 12 regional Federal Reserve districts.

The European Central Bank (ECB) is expected to raise its key benchmark interest rate by 75 basis points from zero to 0.75%. The rate has not been above zero in 10 years.

The only notable companies scheduled to report second quarter earnings this week are Casey’s General Stores, GameStop, Kroger and DocuSign.

Portfolio Strategy

Even though the number of jobs created in August was far less than in July, the data was still considered strong enough for the Federal Reserve to continue its restrictive policies to combat inflation. The employment report also raises questions as to whether or not the U.S. economy is headed for a recession. The traditional definition of a recession is two consecutive quarters of negative GDP. First quarter GDP declined by 1.6% and second quarter GDP fell by 0.9%, meeting the requirements for a recession. However, the National Bureau of Economic Research is responsible for officially declaring if the U.S. economy is in a recession and it uses a number of factors in making its decision. Among these are the jobs data, the number of job openings, the unemployment rate, real household income and spending and industrial production. None of these factors are pointing to a recession at this time and consumer spending has remained fairly strong as household savings grew during the pandemic. Of concern in this tight labor market where job openings far exceed the number of available workers is the decline in real wages due to high inflation. The current economic environment of slow or stagnant growth and high inflation is reminiscent of the 1970s, a period that was characterized by stagflation. But the big difference between then and now is that the job market continues to be strong and unemployment remains low. The odds of a recession occurring when the labor market remains this strong are slim. Other factors such as the Covid-19 pandemic, high energy prices, the war in Ukraine and the trend away from  globalization complicate matters and make predicting a recession that much more difficult.