Stocks close higher on strong jobs data, possible rate hike

If you’re prepared to invest in a company, then you ought to be able to explain why in simple language that a fifth grader could understand, and quickly enough so the fifth grader won’t get bored. – Peter Lynch

Wall Street’s winning streak reached six straight weeks as the major stock averages all posted gains despite increasing concern that the Federal Reserve will raise interest rates in December. The primary catalyst for this fear among investors was the unexpectedly strong October employment report released on Friday. The report showed that 271,000 new jobs were created last month, much higher than the consensus estimate of 185,000, and that the unemployment rate fell to 5% from 5.1%, a 7-year low. The U.S. has now added an average of 206,000 new jobs a month in 2015. Equally important, average hourly earnings increased 9 cents, which was the fastest pace since the end of the recession in 2009. This increase put investors on high alert that the Fed’s inflation target of 2% could soon be met. The only negative in the surprisingly strong jobs data was that the labor participation rate remained stubbornly low. As might be expected, the 10-year Treasury sold off on the news and its yield spiked to 2.33% from 2.15% a week ago. Earlier in the week, in testimony before a House panel, Fed Chair Janet Yellen had braced investors for a move higher in the federal funds rate at the December Federal Open Market Committee (FOMC) meeting by stating that it was a distinct possibility. Without question, the blowout jobs number increases the probability of an interest rate hike next month as the usually reliable federal-funds futures markets now puts the odds of a rate hike at 70%. With the next FOMC meeting a little over a month away, economic data between now and then will be scrutinized for signs of either strength or weakness. If the Fed does commence liftoff, will it be one and done or followed by another rate hike in March as part of a gradual tightening process? Stay tuned.

Last Week

While the October ISM manufacturing index registered a reading that showed the sector is barely expanding, the ISM services index rose to 59 in October, the highest level in three months. Much of this good news in the services sector can be attributed to the low price of gas, which, in effect, acts like a tax cut by giving consumers more income to spend on other things. Similarly, automobile sales reached a 10-year high in October as light truck sales were particularly strong, in part due to low energy prices. Construction spending rose in September and was in line with expectations but factory orders fell for the second straight month. Manufacturing data out of Europe, though, was better than expected.

For the week, the Dow Jones Industrial Average rose 1.4% to close at 17,910 while the S&P 500 Index gained 1% to close at 2,099. The Nasdaq Composite Index jumped 1.9% to close at 5,147.

This Week

The U.S. bond market will be closed in observance of Veterans Day on Wednesday while equity markets will remain open. October retail sales will headline this week’s economic reports and are expected to increase 0.3%, better than the previous month. The producer price index (PPI) for October is also expected to rise modestly and show that inflation remains tame. A number of Federal Reserve presidents will be giving speeches this week on a range of topics but they could deviate from their scripts to comment on Fed policy and the likelihood of an interest rate hike in December.

Economic data out of China has improved recently and this week the country will shed light on its monthly consumer and producer prices as well as industrial production and retail sales. The Shanghai Composite Index has risen more than 20% from its August lows and is once again in a bull market.

The earnings calendar this week will be skewed toward the retailers with Macy’s, J.C. Penney, Kohl’s and Nordstrom all due to report. Other notable companies on the list include Dean Foods, D.R. Horton, Applied Materials and Cisco Systems.

Portfolio Strategy

Investors have vacillated back and forth recently on whether or not a 25 basis point increase in the fed funds rate would be good or bad for the stock market. While the market has been comfortable with the Fed’s continued near-zero interest rate policy, a small increase would definitely send a convincing signal that the economy is strong enough to withstand higher interest rates. With the third quarter earnings season winding down, results have generally exceeded expectations, although those expectations were lowered considerably on concerns over China’s slowing growth, Fed uncertainty and the strong dollar. For the most part, even excluding the energy sector, earnings have not been particularly strong and sales growth has also been lackluster. Recently, though, economic data out of China has stabilized and the Federal Reserve seems poised to raise rates in December, eliminating much of this uncertainty. But higher interest rates could serve to strengthen the dollar further relative to other foreign currencies, hurting profits of multi-national companies doing business overseas. After posting over an 8% increase in October, it would seem that the S&P 500 Index is due for a rest. There may not be many catalysts for stocks with the earnings season coming to an end, but we have entered the month of November, the start of a six-month period that historically has been favorable for stocks. There certainly could be increased volatility near-term considering the stock market’s higher valuation, but additional gains are not out of the question, either.