A strong Friday rally wasn’t quite enough to keep stocks from losing ground this week. The jobs report today was just what the market wanted to see. Reasonably strong job creation coupled with moderate wage gains suggests the Fed will only raise interest rates two more times this year. For the week, the Dow and S&P 500 were each down 0.2% and remain negative for the year.
The April jobs report was released this morning and showed the economy added 164k net new jobs in the month. This was below the consensus estimate of 195k, but still represents a strong monthly number. The unemployment rate declined to 3.9%, the first time it’s been below 4% in 18 years. Part of the reason the unemployment rate declined is people leaving the labor force. It’s unclear whether that’s people who gave up looking for work or left by choice. Since the financial crisis, I’ve argued the unemployment rate has overstated the strength of the labor market. I think that’s supported by the fact that wage growth has been restrained. If the true unemployment was under 4%, we would see a lot more wage growth as companies compete for labor. We might be approaching that point though.
I was talking with two people this week, one sells construction equipment and one is an estimator for a commercial construction company. Both businesses are booming and they can’t find enough people. They are having trouble keeping the employees they have as competitors have hired skilled workers away from them. Wage growth is an interesting phenomenon. If workers make more, they have more money to spend. Consumer spending is two-thirds of the US economy, so increased income is good for economic growth. But it also puts earnings pressure on companies as cost rise, often sooner than they can increase prices for their own products. We’ve been in a pretty balanced 2% to 2.5% wage growth range for a number of years, but an increase to 3%+ could pressure stock prices in the short-term.
Oil increased this week, gaining 2.7% to close at $69.82/barrel. The yield on the 10-yr Treasury ticked lower, closing at 2.95% from 2.96% last week. The average rate on a 30-yr fixed rate mortgage retreated to 4.55% from 4.58% a week ago.
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Multiple issues helped created another volatile week for stocks. Interest rates came back to the forefront as the 10-year Treasury touched 3% for the first timein four years. While still a very low level historically, the 10yr traded under 1.4% less than two years ago and 2.4% at the beginning of the year. More interestingly, the 2-year Treasury is approaching 2.5%. That’s more than double the yield at the beginning of the year. That provides some investors an enticing opportunity to reallocate away from stocks and into bonds, putting some pressure on stock prices. For the week, the Dow declined 0.6% while the S&P 500 was essentially flat from last Friday.
First quarter economic growth came in at a better-than-expected 2.3% annualized rate in the initial report. Economists were expecting a 2% growth rate. This is sharply lower than we’ve seen over the past three quarters, but the first quarter is typically lower due to some seasonal adjustments. Higher economic growth has been a key target of the Trump administration. As of now, growth approaching 3% this year seems possible although there were some concerning aspects of this report. Consumer spending was the weakest in the last five years. Consumers make up roughly two-thirds of overall gross domestic product, so any prolonged weakness in consumer spending will cause a hit to economic growth. Read More
Companies have consistently exceeded earnings expectations this quarter. Earnings were expected to be strong given the tax cuts and a weak dollar, but have so far been even better than analysts estimated. While the numbers have been good, the stock market reaction has been all over the place. This highlights a couple important points. During this week we’ve seen headlines such as “Strong Earnings Not Enough to Make Investors Happy” and “Markets Surge, Powered by Strong Earnings.” These are completely opposite headlines in back-to-back days. The point is day-to-day market moves often have very little to do with the fundamental strength of companies or the economy. The key is to try and ignore the short-term noise and buy quality companies with a long-term horizon.
Oil decreased slightly this week, declining 0.4% to close at $67.97/barrel. The yield on the 10-yr Treasury held steady at 2.96% after topping 3% earlier in the week. The average rate on a 30-yr fixed rate mortgage moved sharply higher to 4.58% from 4.47% a week ago. This is the highest average mortgage rate in over four years.
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Earnings took center stage in financial markets this week. So far, earnings have generally been better than expected. Much of the gain has been driven by the tax cuts, but we have also seen strong revenue growth. The weak dollar has also helped sales and earnings as foreign earnings are worth more in dollar terms when the dollar is relatively weak. While tax cuts and a weak dollar are providing non-company specific tailwinds to earnings, we are also seeing companies genuinely perform well. For the week, the Dow gained 0.4% while the S&P gained 0.5%.
Wells Fargo has been in a news a lot over the last year since a scandal involving the bank setting up new accounts for unsuspecting customers and then charging fees on those accounts. This week, the government imposed a $1 billion fine on the bank for the activity and retained the unprecedented authority to fire managers and even adjust business strategy going forward if regulators feel the bank is engaged in other bad behavior. Many observers wondered how the Trump administration would handle this case given its more business friendly stance on many issues. This shows the penalty for legitimate wrongdoing remains very high. Read More
A new study out this week suggests many Americans are worried about the financial viability of Social Security. 51% of pre-retirees, those aged 50-64, are concerned the program won’t be able to pay them their full benefits. I’m surprised the figure is that low. Social Security faces several challenges that will make paying full benefits to all recipients difficult. The number of workers paying into the system relative to the number receiving benefits keeps declining. In 1955, there were more than eight workers for each beneficiary. Today there are less than three. As a result the system is no longer collecting in payroll taxes as much as it pays in benefits. The Trust Fund is supposed to make up that difference, but the reality is there is no real trust fund. There isn’t $2.5 trillion sitting in a bank account waiting to pay SS benefits. The Trust Fund money has all been spent and the government has to borrow the money owed to the Trust Fund to meet those obligations. The system won’t implode, but many people in the years to come could see lower benefits. Means-testing benefits seems like an easy answer, but even beyond that, it seems likely that benefits for many will have to be cut. Current beneficiaries will likely see minimal impact, but people expecting to receive benefits in the future should plan their retirement with a smaller Social Security benefit. Read More
Oil increased again this week, rising 1.5% to close at $68.26/barrel. The yield on the 10-yr Treasury moved sharply higher to 2.96% from 2.82% last week. The average rate on a 30-yr fixed rate mortgage moved higher to 4.47% from 4.42% a week ago.
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Earlier this week, Chinese President Xi Jinping stated China would consider changes to its import tariffs on some US goods. The headline soothed investors as it appears the world’s two largest economies would find common ground and avert a trade war. The headlines were more positive than some of the details, but it still suggests negotiation will win the day and both sides will avoid the pitfalls of a trade war. The news helped push stocks higher for the week, with the Dow gaining 1.8% while the S&P 500 increased 2.0%. Both indices remain negative on the year.
Earnings season kicked-off today with several major banks reporting this morning. JP Morgan, Citibank and Wells Fargo all reported better than expected earnings, but saw their stocks trade down on the news. Stock behavior around earnings is always a wild card, but today’s down trade suggests the market as a whole was more optimistic about earnings than wall street analysts. While the headline numbers looked good, there were some concerning aspects of these reports. Lending wasn’t overly robust and trading revenue wasn’t as strong as many expected given the market volatility. Read More
This is the first quarter of earnings since the new tax law went into effect. This is creating more uncertainty than usual. While tax rates were lowered, some rules around deductions changed and so estimating earnings was more difficult than normal. This could lead to a divergence in actual results versus estimates and some additional volatility than normal for an earnings period. Next week, blue chips such as Johnson & Johnson, American Express, Proctor & Gamble, IBM and others report 1st quarter earnings. Over the next three weeks, most of the companies in the S&P 500 will report earnings. Earnings is always a good time to get a sense of how companies are performing and what they think about the state of the overall economy.
Oil increased sharply this week, rising 8.7% to close at $67.25/barrel. The yield on the 10-yr Treasury moved higher to 2.82% from 2.78% last week. The average rate on a 30-yr fixed rate mortgage moved higher to 4.42% from 4.40% a week ago.
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