S&P 500 posts gains on higher oil prices, economic data

It’s always said that the small investor doesn’t have a chance. And if they (people) so believe this theory that the small investor has no chance, they invest in a different format. – Peter Lynch

Stocks posted gains for the third consecutive week as economic data continued to be better than expected and the price of oil and other commodities rose, suggesting stronger growth on the horizon. With the fourth quarter earnings season largely in the rear view mirror, investors have relied on macroeconomic data recently to chart the direction of the stock market and that news has been mostly positive. Negative sentiment that had embraced investors in January and the first half of February has been replaced by optimism that the economy is poised to improve and that corporate profits will follow suit. The fact that the S&P 500 Index closed comfortably above 1,950, a level that had provided strong resistance lately, might be an encouraging sign over the near-term. The labor market also remains strong and has been one of the consistent bright spots in the overall economic picture. That strength was again evident in the February employment report released on Friday as 242,000 new jobs were created and the unemployment rate remained unchanged at 4.9%. This number far exceeded projections of 190,000 new jobs and both the December and January job numbers were also revised higher. Even the labor participation rate rose and reached its highest level in more than year. The only downside to the report was that average wages fell slightly and most of the new jobs were in lower paying fields in the retail, restaurant and hospitality industries. Wage growth continues to be elusive and one would have expected that the higher payroll numbers would have translated into increased hourly earnings, but that has not been the case. The rise in overall commodity prices last week and particularly oil, which has risen over 35% from its lows, also contributed to improved investor sentiment as recession fears gave way to a more sanguine outlook for global growth.

Last Week

Most of the stock market gains last week occurred on Tuesday when the February ISM manufacturing index came in at 49.5, better than the reading in January and above expectations. Construction spending for January was also released and rose to the highest level since 2007. The February ISM non-manufacturing index was 53.4, slightly better than expected, while factory orders for January were less than forecast. The ADP private sector jobs report also confirmed a strong labor market as it showed 214,000 new jobs in February, much more than forecast.

The Federal Reserve’s Beige Book of economic activity showed that consumer spending increased in most of the regional districts but that manufacturing activity was flat. Manufacturing continues to be affected by a strong dollar, weak demand from the energy sector and sluggish economies overseas.

For the week, the Dow Jones Industrial Average added 2.2% to close at 17,006 while the S&P 500 Index gained 2.2% to close at 1,999. The Nasdaq Composite Index jumped 2.8% to close at 4,717.

This Week

The most important news events this week will occur in Europe as the European Central Bank (ECB) convenes to discuss ways to stimulate the economy, most likely by cutting deposit interest rates further. European Union leaders will also hold a summit meeting to address the refugee crisis and euro zone finance ministers will meet to discuss reforms in Greece and Cyprus. Import prices for February are expected to fall nearly 1%, helped in part by the continued strength of the dollar.

With earnings season winding down, mostly smaller, less prominent companies are on tap this week to report their earnings. Retailers such as Dollar General, Stein Mart, Children’s Place, Urban Outfitters and Casey’s General Stores will once again be the center of attention.

Portfolio Strategy

For the past few months, there has been a strong correlation between the price of oil and the direction of the broad stock market as defined by the S&P 500 Index. Although the energy sector comprises less than 10% of the total market capitalization of the benchmark, its effect on stocks has been uncanny. In fact, the price of oil and the broad stock market have moved in tandem more than 75% of the time so far this year. Oil has also experienced tremendous volatility with moves of 5% or more not uncommon. The last time that oil has been this volatile was during the global financial crisis back in 2008 and 2009. U.S. oil inventory reports last week showed a continued decline in production, which contributed to oil’s rise to just under $36 a barrel. But the precipitous drop in the price of oil from more than $100 a barrel in June 2014 has been caused by an increase in supply from Saudi Arabia and other OPEC countries coupled with a glut of U.S. shale oil. A strong dollar and slowing global demand only exacerbated the problem. As a result, energy companies have been forced to sell assets and reduce capital expenditures in order to raise and preserve cash. Many oil companies, such as Anadarko Petroleum, ConocoPhillips and Marathon Oil, have recently slashed their dividends as a way to preserve cash and maintain their investment-grade debt ratings. Until oil production is cut and inventories are reduced or demand for oil increases significantly, the price will likely remain volatile and have a corresponding similar effect on the stock market. Only when the price of oil finally recovers and stabilizes will the stock market be able to decouple and move independently of oil’s price movements.