S&P 500, Nasdaq at record highs on strong jobs data

Your success in investing will depend, in part, on your character and guts, and in part on your ability to realize at the height of ebullience and the depth of despair alike, that this too shall pass. – John Bogle

Both the S&P 500 Index and the Nasdaq Composite Index closed at record highs on Friday after the government released the employment report for July that surpassed even the most optimistic projections. Most economists had forecast job growth of about 180,000, but U.S. employers created 255,000 new jobs in the month, a welcome sign after the dismal second quarter gross domestic product (GDP) number of only 1.2%. The July unemployment rate remained unchanged at 4.9% and hourly wages increased by 8 cents to an annualized rate of 2.6%. Not only was it a blowout jobs number in July, but the number of jobs created in May and June was also revised higher. What made the employment report even more impressive was the fact that the job gains were evenly distributed across all sectors of the economy. While the strong labor market data makes it more likely that the Federal Reserve will raise interest rates in September, fears that the economy was stalling and possibly headed for a recession were put to rest. Stocks also received a boost after the Bank of England cut interest rates for the first time since 2009 as the outlook for growth deteriorated following the decision by the United Kingdom to leave the European Union. It also increased its government bond-buying program in order to ward off a possible recession. Although the odds of a Fed rate hike in September have increased, they still remain low, especially with this latest move by the Bank of England and the existence of negative interest rates in Europe and Japan and the possibility of even more stimulus measures. Meanwhile, second quarter corporate earnings continue to be better than expected and guidance for the rest of the year has fewer downward revisions, making investors more comfortable with earnings estimates and the forecast of improved economic growth in the second half.

Last Week

Jobless claims rose by 3,000 last week to 269,000, marking the highest level since the end of June. Despite the increase, the labor market still remains healthy as there have been very few layoffs. In fact, the labor market has experienced the largest expansion since the 1990s. The U. S. trade deficit jumped to a 10-month high in June due to greater amounts of consumer goods and oil being imported. Factory orders fell modestly in June and were in line with expectations.

For the week, the Dow Jones Industrial Average added 0.6% to close at 18,543 while the S&P 500 Index gained 0.4% to close at 2,182, a record high. The Nasdaq Composite Index rose 1.1% to close at 5,221, also a record high.

This Week

Retail sales for July are expected to rise only modestly due in part to falling gas prices and should increase by a smaller percentage than in June. The July producer price index (PPI) is forecast to tick slightly higher as declining gas prices are expected to have an effect. The University of Michigan sentiment index is expected to increase over last month’s reading and show a confident consumer based on an improved labor market and better wage growth.

China will release a number of important economic reports, including monthly producer and consumer prices as well as industrial production and retail sales.

Retailers will headline this week’s earnings reports as J.C. Penney, Macy’s, Kohl’s and Nordstrom are on the agenda. Other notable companies scheduled to report include Allergan, Dean Foods, Tyson Foods, Coach, International Flavors and Fragrances and Walt Disney.

Portfolio Strategy

Over the past year, the best-performing equity exchange-traded funds or ETFs have been those that buy stocks with above-average dividend yields or companies that have consistently increased their dividends year after year. Many of these ETFs have posted double-digit total returns during the last year compared to only about 6.30% for the S&P 500 Index. With the 10-year Treasury yield hovering around 1.50%, many of these ETFs also provide attractive yields (in some cases 3% or more) as well as reliable dividend growth prospects. Three of the better-performing dividend-oriented ETFs have been the SPDR S&P Dividend ETF (SDY), the iShares Core High Dividend ETF (HDV) and the ProShares S&P 500 Dividend Aristocrats ETF (NOBL). SDY currently yields 2.4% and has posted a total return of 18.05% over the past year while HDV yields 3.3% and has returned 15.22% over the same time period. Both of these ETFs have utility weightings that are less than 12%, which is reasonable considering that valuations have become stretched on utility stocks as investors have piled into them for their yields compared to what Treasuries and corporate bonds offer. NOBL, which requires that its companies be part of the S&P 500 Index, have increased dividend payments for at least 25 years and meet market capitalization and liquidity requirements, currently yields 1.78% and has posted a total return of 11.95% during the past year. This type of dividend growth fund also has less interest-rate risk since the companies tend to increase their dividend in line with their earnings growth. A healthy allocation to these dividend-oriented ETFs has probably enabled investors to outperform the S&P 500 Index so far this year in the equity portion of their portfolios.