In the wake of Friday’s payroll report and the Trump Administration’s announcement that many Dodd-Frank regulations might be repealed, the stock market surged on Friday, led by the financial stocks. The Dow Industrials shot back over 20,000 on Friday, while the S&P 500 closed in on a new all-time high around 2,300. No matter what the Trump Administration and its many critics keep throwing at us, the market usually focuses more on corporate earnings than politics. Since we are in the middle of earnings season, stocks with strong sales, earnings, and forward guidance will likely continue to lead the market.
The good news is that the earnings environment is likely going to get better as 2017 unfolds, especially if corporate tax reform is passed. The only wild card is just how much a strong U.S. dollar may impede GDP growth, like it did in the fourth quarter. Obviously, the Trump Administration is striving for 4% annual growth, which is very ambitious, but high consumer and business confidence could deliver 3+% growth.
For the first four days of last week, there was a rotation out of “Trump stocks” (like financials, industrials, materials, and energy stocks – which have done so well since the election). Some of this exodus appears to be caused by Congressional grumbling about healthcare reform, tax reform, the new Supreme Court pick, and other Trump moves. The fear that more bottlenecks in Congress might slow some key parts of the Trump Administration’s agenda have “spooked” the market, but I’d say that the main reason why these Trump stocks were spooked is that many of them are simply not characterized by strong enough sales or earnings.
Last Wednesday, the Federal Open Market Committee (FOMC) kept key interest rates unchanged because business investment remains “soft.” However, the FOMC statement also said that “measures of consumer and business sentiment have improved of late.” This two-sided double speak (“on the one hand” and “on the other hand”) statement by the Fed implies that there may not be another rate hike at its March FOMC meeting, unless there is sufficient economic evidence that economic growth and inflation are both rising.
However, two days after the Fed met, we saw better-than-expected job growth and continued wage increases. Since Fed Chair Janet Yellen is primarily a labor economist, these are two measures she is watching closely when it comes to raising rates. She will be testifying before Congress February 15th, so Fed watchers will have to wait until then to try to get more insight into the “data dependent” FOMC.
Speaking of jobs, the big news last week was the January payroll report. The Labor Department reported last Friday that 227,000 payroll jobs were created in January, well above the economists’ consensus estimate of 175,000. But that positive surprise was offset by the 39,000-job downward revision of the previous two months. Also, the unemployment rate rose to 4.8% in January, up from 4.7% in December, because 584,000 entered the workforce in January. Average hourly wages rose by just 3 cents (+0.1%) to $26 per hour, but wages are still up 2.5% in the past 12 months. In a parallel report on Wednesday, ADP reported that 246,000 private payroll jobs were added in January – well above the estimates of 168,000.
Another Wave of (Mostly) Positive Economic Statistics
On Tuesday, the Conference Board announced that its consumer confidence index slipped from a 15-year high of 113.3 in December to 111.8 in January. Economists were expecting the index to slip to 112.9 in January, so the dip was larger than expected. The primary reason for this decline was that the expectations component plunged to 99.8 in January, down from 106.4 in December. However, the present situation component surged to 129.7 in January, up from 123.5 in December. So overall, consumers are confident.
On Wednesday, the Institute of Supply Management (ISM) reported that its manufacturing index rose to 56 in January, up from 54.5 in December, significantly higher than economists’ consensus estimate of 55 and the fifth straight monthly rise. The ISM manufacturing index is now at the highest level since November 2014, so the manufacturing sector is still growing despite the headwinds of a strong U.S. dollar.
On Thursday, the Fed announced that productivity slowed dramatically from a 3.5% annual pace in the third quarter to only 1.3% in the fourth quarter. According to the Fed, labor costs were rising at a 1.7% annual pace in the fourth quarter, up from a 1.5% pace in the third quarter. For all of 2016, productivity rose only 0.2%. Since rising productivity often helps to boost wages, any deceleration in productivity is a concern for the Fed, since it means that wage growth may also slow. Overall, the deceleration in productivity may be another reason why the FOMC could decide to postpone any rate increase in March.
On Friday, the ISM service index slipped slightly to 56.5 in January, down from 56.6 in December. The ISM component for new orders and inventories declined, which suppressed the overall ISM service index. Overall, since any reading over 50 signals an expansion, the ISM service index remains very encouraging.
Turning back to the market, we will likely continue to see rapid sector rotation since the explosion of ETFs has promoted “theme” investing – where investors can jump on (or off) any bandwagon. As wave after wave of companies announce their fourth-quarter results and first-quarter guidance, “cracks” have emerged in the foundation supporting many Trump-Bump stocks. Specifically, many energy and financial stocks are posting better quarterly results and have a rosy outlook. Unfortunately, many industrial and materials stocks are struggling and will not have the strong sales and earnings that I demand until late 2017 or 2018.
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