Stock market’s winning streak comes to an end

The individual investor should act consistently as an investor and not as a speculator. This means that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that satisfies him that he is getting more than his money’s worth for his purchase. – Benjamin Graham

The stock market’s winning streak of eight consecutive weeks came to an end as investors had difficulty determining whether or not good economic news should be viewed as good news or bad news as stocks seesawed back and forth. In the final analysis, investors threw in the proverbial towel on Friday and decided that the strong employment data should be regarded as favorable for stocks as the major averages were up about 1% for the day. If this schizophrenic behavior has you confused, don’t feel bad because you are not alone. Earlier in the week, strong manufacturing data, a better than expected ADP jobs report and a upwardly revised 3^rd quarter GDP report sent shivers through the stock market as investors feared, rightly or wrongly, that the Federal Reserve would begin the dreaded tapering process as soon as their next meeting later this month. Stocks were poised to finish the week sharply lower across the board before investors had a change of heart and concluded that maybe good economic news in terms of a lower unemployment rate and over 200,000 new jobs created should be perceived as such. Perhaps the economy is ready to stand on its own two feet without the help of the Fed and its stimulus program.

Last Week

For the most part, the economic news last week was overwhelmingly positive and indicative of an economy that may be able to withstand Fed tapering. New home sales jumped 25% in October to the highest level in four months. The ISM manufacturing index rose to a 2-year high and the revised 3^rd quarter GDP report showed that the economy expanded at a 3.6% annual rate, much better than expected and the fastest increase in almost two years. The strong growth was caused by a huge buildup in inventories that could prove to be temporary in subsequent quarters if these goods are not sold. Corporate profit growth as a percentage of GDP was also encouraging as it reached a record of 10.8%.

Jobless claims last week dropped to below 300,000 as applications reached their lowest level since the end of the recession. While the ADP jobs report and the government jobs report both showed an increase of over 200,000 jobs, the unemployment rate also fell to 7.0%, the lowest level in five years. Much of the strength in the jobs data could be attributed to the end of the government shutdown and some seasonal hiring on the part of retailers. But a moderately expanding economy led by improving manufacturing and housing sectors bode well for next year.

For the week, the Dow Jones Industrial Average dropped 0.4% to close at 16,020 while the S&P 500 Index shed less than a point to close at 1,805. The Nasdaq Composite Index bucked the trend as it increased slightly to close at 4,062.

This Week

Unlike last week, this week’s economic calendar is sparse and offers only a few reports for investors to evaluate. Retail sales for November are expected to increase about 0.6% as automobile sales continue to surprise on the upside. The jury is still out, however, on the holiday shopping season as a late Thanksgiving could adversely affect sales. Producer prices for November should rise only 0.1% as overall demand remains fairly weak and inflation remains subdued. The small business optimism index also is due to be released and should be positive as hiring by small businesses as been very strong. Finally, jobless claims should continue the trend lower as the rate of layoffs declines.

As the earnings season slows to a trickle, among the companies scheduled to report include Toll Brothers, Autozone and Pep Boys, Costco and Adobe Systems.

Portfolio Strategy

The positive reaction to the strong employment data by the stock market could be a hopeful sign that investors are finally comfortable with the inevitability of Fed tapering. The economy seems to be gathering some momentum that could eventually lead to sustained, moderate growth that would allow the support of Fed stimulus to be gradually removed. The Fed meeting scheduled for next week probably does not allow enough time to reach a definitive decision one way or another. With Chairman Ben Bernanke’s term set to expire in January and Janet Yellen’s tenure to begin on Feb. 1^st, it seems logical that the Fed would let the new chair settle in to her new position before beginning the reduction of the stimulus program. This scenario would call for the start of Fed tapering sometime in March. If that turns out to be the case, then it appears that stocks have the wind at their backs, at least for the balance of this year, barring any unforeseen circumstances. Stocks still trade at a reasonable multiple of about 17 times this year’s earnings, compared to almost 19 times for the average over the past 25 years. The steady climb higher by stocks this year without as much as a 6% correction in prices also has been highly unusual. Somewhere out there is a correction lurking behind the corner, but what causes it, when it happens and how much it affects stocks is the question with no answer.

While the stronger than expected economic data last week caused weakness in the bond market, the yield on the 10-year Treasury remains range-bound between 2.5% and 3.0% as it closed at 2.86%. With the Fed committed to keeping short-term interest rates low into 2015, it’s possible that stronger growth could lead to higher longer-term rates, but the process should be gradual and nothing like the spike in rates we experienced earlier this year.