Strong employment data lifts Dow, S&P 500 to record highs

My experience indicates that most people who’ve accumulated a great deal of wealth haven’t had that as their goal at all. Wealth is only a by-product, not the original motivation. – Michael Milken

The Dow Jones Industrial Average and the S&P 500 Index continued their torrid pace last week as both major averages closed at record highs on news of a blowout jobs report and the possibility of further stimulus measures by the European Central Bank (ECB). Earlier in the week, a solid ADP private sector jobs report was a precursor to a surprisingly strong government report of 321,000 new jobs in November, which was much better than expected and the biggest monthly gain in almost three years. Virtually every industry added jobs and it was the tenth straight month that at least 200,000 jobs have been added to the economy. Unlike previous employment reports, though, wage growth rose 0.4%, an encouraging sign that coupled with lower gasoline prices should help boost consumer spending. With the price of oil under $70 a barrel, consumers in effect have been given a huge tax cut that will benefit economic growth. The stock market also may have received a boost from ECB President Mario Draghi, who hinted that additional stimulus programs are being considered to spur economic growth in the euro zone, which has been teetering on the brink of recession. While investors may have been somewhat disappointed that there was no immediate implementation of a stimulus plan, Draghi reiterated the central bank’s intention to do whatever it takes to promote economic growth. The governing council of the ECB also agreed that interest rates would remain at current low levels. It now seems like a foregone conclusion that full-blown quantitative easing will be adopted sometime in early 2015. With weak manufacturing activity reported by Germany, France and Italy earlier in the week, time is running out and the ECB really has no other means with which to revive its slumping economy.

Last Week

Like Europe, China’s economy also continued to show weakness despite recent cuts in key loan and deposit rates. Recent data suggest that manufacturing has lost its momentum and business investment, industrial production, consumption and lending activity have all been weaker than expected. Although China’s GDP growth was 7.3% in the third quarter, this was the slowest pace of growth in more than five years.

In the U.S., October construction spending rose 1.1% and was stronger than expected while November car and light truck sales were the second highest in eight years. The Beige Book released by the Fed also painted a rosy picture of the economy based on lower gasoline prices, higher holiday spending and stronger employment growth.

For the week, the Dow Jones Industrial Average jumped 0.7% to close at 17,958, a new all-time high and the 34^th record of the year. The S&P 500 Index climbed 0.4% to close at 2,075, also a new all-time high and the 49^th record of the year. The Nasdaq Composite Index lost 0.2% to close at 4,780.

This Week

Retail sales for November are expected to increase by 0.4%, slightly better than the previous month. While holiday sales over Black Friday weekend fell 11% from a year earlier according to the National Retail Federation, declines were partly due to the fact that the economy is better. While this sounds contradictory, consumers realize that they don’t necessarily have to rush out to get the best deals since there will be more deals later. Some of the weakness was probably due to better online offerings, too. Overall holiday sales are forecast to increase about 4%, compared to 2.9% last year.

The producer price index (PPI) for November is expected to edge lower by 0.1% as inflation at the wholesale level continues to be benign.

Among the companies slated to report earnings this week are H&R Block, Autozone, Pep Boys, Toll Brothers, Adobe Systems and Costco Wholesale.

Portfolio Strategy

While the strong jobs report in November contributed to both the Dow and S&P 500 hitting all-time highs, it also caused the yield on the 10-year Treasury to rise to 2.32% from 2.25%. The number of new jobs that were created was about 100,000 more than expected and the prior two months were revised higher by 44,000 jobs. More importantly, the unexpected increase in wages means that wage growth has been 2.1% over the past year. The economy now has created an average of over 225,000 new jobs each month for the past ten months and shows no sign of losing its momentum anytime soon. Yields at the short end of the yield curve have risen more sharply while the 30-year Treasury yield is currently just below 3.0%. This flattening of the yield curve will probably continue but longer-term rates are likely to stay relatively low due to economic weakness in Europe and even lower yields there. A strong dollar, low oil prices and weak commodity prices should also serve to keep inflation at bay and prevent the Federal Reserve from having to hike interest rates for the foreseeable future. Depending on one’s tax bracket, fixed income investors should focus on either high quality corporate bonds or municipal bonds that mature in the 5 to 10 year range. This is the part of the yield curve that seems to offer the most value.