S&P 500 near all-time high on strong jobs data for June

I never make a prediction that can be proved wrong in 24 hours. – Louis Rukeyser

Worries that the weak May employment report could be an ominous sign of a slowing U.S. economy were eliminated on Friday as the June jobs report far exceeded everybody’s expectations. As a result, the S&P 500 Index soared over 1.5% on the news after trading around the flat line most of the week. The strong finish to the week propelled the S&P 500 to within one point of its all-time closing high of 2,130 set in May 2015. The June employment report showed that 287,000 new jobs had been created, far better than the 175,000 jobs that were expected and more than ten times the revised May jobs total of just 27,000. Although the unemployment rate rose slightly to 4.9% from 4.8%, the reason for the increase was that more people entered the labor force to find work. As a result, the labor participation rate ticked higher. To be sure, the pace of job creation has slowed in the past several quarters and over the past three months, the average monthly job gains have only been 147,000. Another bright spot in the employment report was a slight increase in the average hourly earnings to $25.61. The strong jobs report enabled investors to breathe a sigh of relief that the economy wasn’t rolling over and heading for a recession. Despite the blowout jobs number, the yield on the 10-year Treasury actually fell on Friday to 1.37%, a record low. This downward move, however, was due more to the continued fallout from the Brexit vote and the decision by the United Kingdom to leave the European Union. Central banks in Europe and Japan have also implemented easy monetary policies, bond-buying programs and negative interest rates in the hope of stimulating their sluggish economies. These moves have placed tremendous downward pressure on interest rates. Not only are U.S. markets considered the safest port in the storm, but yields on our government securities are far more attractive than yields on comparable government debt in most other developed countries.

Last Week

In addition to the strong June employment report, other jobs data last week was also encouraging. The ADP private sector jobs report showed that 172,000 jobs had been created compared to 159,000 that were expected. Most of the gains were in small business jobs. The weekly jobless claims also fell 16,000 to 254,000, marking 70 straight weeks that claims have held below 300,000, a positive sign that the labor market continues to exhibit strength. The ISM non-manufacturing index hit a 7-month high in June and easily beat expectations as the services sector remains resilient and continues to expand.

Minutes from the most recent Federal Reserve meeting showed that policymakers were prudent to wait for more economic data and the results from the Brexit vote before making their decision not to raise interest rates in June. They also cited a slowdown in hiring as a reason to keep interest rates unchanged.

For the week, the Dow Jones Industrial Average rose 1.1% to close at 18,146 while the S&P 500 Index added 1.3% to close at 2,129. The Nasdaq Composite Index gained 1.9%% to close at 4,956.

This Week

It will be difficult to top last month’s strong retail sales number as June retail sales are only expected to increase slightly. Both the June producer price index (PPI) and the consumer price index (CPI) are expected to increase modestly but still show that inflation remains well under control.

China reports data on its second quarter gross domestic product (GDP), the Fed issues its beige book on regional economic conditions and a number of Federal Reserve presidents will speak on the economy and monetary policy.

Alcoa kicks off the start of second quarter earnings season and will mostly be followed this week by financial institutions and banks, including JP Morgan Chase, Wells Fargo, Citigroup, U.S. Bancorp and PNC Financial Services. Other prominent companies on the calendar include Delta Air Lines, CSX and Yum Brands.

Portfolio Strategy

As we begin the second half of the year and with the S&P 500 Index near its all-time high, it is interesting to recap the year-to-date performance of various asset classes. The single best performing asset class has been commodities with most broad-based commodity funds up about 15% and gold up a surprising 24%. The other asset class that has provided investors with outsized returns has been real estate investment trusts or REITs with the U.S. REIT Index up 15% through Friday’s close. Both commodities and REITs are considered alternative investments as they tend to behave differently that either stocks or bonds and provide a way for investors to get additional diversification that should reduce the risk of their portfolios. As far as equities are concerned, the S&P 500 Index has returned 5.4%, with so-called value funds performing better and growth funds trailing the benchmark. Funds that emphasize companies with above-average dividend yields as well as those that consistently increase their dividend year after year also have easily beat the S&P 500, with returns approaching 10% or more in some cases. Small cap stock funds have also generally outperformed this benchmark while mid-cap stock funds have posted returns that are mostly in line with the S&P 500. The worst performing asset class has been developed market international equity funds as returns have been flat to slightly negative. The outcome of the recent Brexit vote, weak economic growth and currency translations have all contributed to the disappointing performance of these funds. Surprising as it may seem, intermediate bond funds have trounced the S&P 500 Index with returns around 6% or 7% as strong demand for fixed income securities has increased their price and caused their yields to plunge. Intermediate municipal bond funds have also done very well with total returns of about 4%. Most well-diversified portfolios with exposure to these asset classes and overweighted positions in value and high dividend-paying or dividend growth stocks, a modest allocation to REITs, commodities and/or gold and an underweight in developed market international stocks have probably beaten the S&P 500 Index so far this year.