Volatile week ends with S&P 500 virtually unchanged

In the long run, it’s not just how much money you make that will determine your prosperity. It’s how much of that money you put to work by saving it and investing it. – Peter Lynch

The S&P 500 Index ended the week virtually unchanged but that does not tell the whole story as stocks went on a roller-coaster ride that was filled with ups and downs. The increased volatility was the result of mixed U.S. economic data, central bank policies that seem headed in opposite directions and resumption of a decline in oil prices. After starting the week at 2,090, the S&P 500 Index actually plunged to 2,050 on Wednesday before rallying and finishing the week with a flourish at 2,091, a gain of just 0.1%. While both the November ADP private payroll jobs report and the November U.S. government employment report showed an increase of over 200,000 new jobs, manufacturing data was disappointing and actually showed a sector that was slowing and even contracting. In addition, the normally strong services sector index fell more than expected last month but was still comfortably in expansion territory. Central bank policies also conveyed mixed messages last week. In a speech to the Economic Club of Washington, Federal Reserve Chair Janet Yellen made it perfectly clear that she would support an interest rate hike when the Fed meets on December 15^th and 16^th. The reality of liftoff and the beginning of the process of normalization of monetary policy unnerved investors. Even though European Central Bank (ECB) President Mario Draghi announced that their bond-buying program would be extended to at least March 2017, investors had expected more stimulus measures and came away from the meeting disappointed. European stocks sold off on the news and U.S. stocks also turned negative. Adding to the weakness in stocks was a drop in oil prices to below $40 a barrel as U.S. oil inventories remained high and the Organization of Petroleum Exporting Countries (OPEC) did not make a decision to reduce output. But the best and most important news of the week was saved for last as the strong U.S. employment report on Friday was cheered by investors and allowed stocks to get back to even for the week.

Last Week

Manufacturing data was weaker than expected as both the Chicago Purchasing Managers Index (PMI) and the Institute for Supply Management (ISM) manufacturing index registered below 50, indicating contraction. Factory orders rose modestly and were in line with expectations. As mentioned above, the jobs data last week was strong across the board. ADP’s report on private payrolls was up 217,000, jobless claims recorded their 39^th consecutive week below 300,000 and the November employment report showed the creation of 211,000 new jobs, upward revisions to previous months and an unemployment rate that remained at 5%. An average of 218,000 new jobs has been created over the past three months. The Fed’s Beige Book confirmed an economy that continues to grow at a modest or moderate pace in most regions of the country.

For the week, the Dow Jones Industrial Average rose 0.3% to close at 17,847 while the S&P 500 Index edged higher by 0.1% to close at 2,091. The Nasdaq Composite Index gained 0.3% to close at 5,142.

This Week

There is very little in the way of significant economic data to be released this week. The most important report will come on Friday as retail sales for November are expected to rebound with a gain of 0.3%. The November producer price index (PPI) is forecast to remain flat as inflation remains well under control. The University of Michigan consumer sentiment index is expected to top last month’s reading as consumers are encouraged by the recent strong jobs data and improving wages.

The earnings calendar this week will again be light with the most prominent companies due to report being Costco Wholesale, Adobe Systems, Toll Brothers, Autozone, Pep Boys and H&R Block.

Portfolio Strategy

The strong November employment report almost certainly means that the Federal Reserve will raise the federal funds rate at their meeting in just over a week. The Fed has been anxious to begin liftoff from their near-zero interest rate policy and the 211,000 new jobs created last month gives them the opportunity to do so. But a rate hike by the Fed doesn’t necessarily mean that interest rates in general will also rise or that bond prices, which move inversely to rates, will fall. Prior to the release of the jobs report, the yield on the 10-year Treasury had already risen to 2.33% and actually fell back to 2.27% after release of the strong report. The Federal Reserve has long-maintained that any rate increases will be dependent on incoming economic data and has emphasized that the pace of such hikes is likely to be gradual. With only modest economic growth, benign inflation, weak commodity prices, a strong dollar, low oil prices and weak overseas economies, it is by no means certain that interest rates will continue to climb. The initial rate hike will eliminate a lot of uncertainty, which is a positive, but there are more than enough head winds facing the economy that could keep interest rates at these levels for quite some time. The fact that U.S. interest rates are higher than rates in both Europe and Japan where central banks are easing should attract foreign buying interest and help keep a lid on rates. While the Fed might believe that it’s time to raise interest rates, the bond market may have other ideas.