Weekly Markets Commentary — February 6, 2017
David Joy – Chief Market Strategist, Ameriprise Financial
How’s the U.S. Economy Really Doing?
The U.S. economy showed evidence of improvement last week, despite the fourth quarter slowdown. Job creation in January easily exceeded expectations as the economy generated 227,000 new non-farm jobs. It was the strongest gain since September, beating the consensus forecast of 180,000 and far outpacing the fourth quarter monthly average of 148,000. The unemployment rate rose to 4.8 percent as more potential workers joined the labor force. The participation rate climbed to 62.9 percent, equaling its September level, although it remains well below its 66.1 percent average in the five years prior to the financial crisis. Some of that difference is attributable to discouraged workers, some is attributable to lack of employable skills, and some is due to changing demographics as baby boomers retire.
The one surprise in the employment report was a decline in average hourly wages. As job growth has continued throughout the recovery and employable workers become increasingly scarce, wages should be expected to rise as the competition for their services intensifies. Indeed, after bottoming at a year-over-year gain of just 1.6 percent in October, 2012, wages had accelerated to a gain of 2.8 percent in December. But in January these gains took a step backward, when they grew at just a 2.5 percent pace. While somewhat surprising, the decline is expected to be temporary, apparently having been distorted, at least in part, by the mix of jobs created.
Economic Data Shows the Recovery Remains Somewhat Choppy
The pullback in wages resulted in investors lowering slightly their expectations for a Fed rate increase in March. Prior to the report, futures pointed to a 32 percent chance of an increase, which fell to 30 percent after the report. There was little impact for such expectations at future Fed meetings. June remained at 48.6 percent likelihood, while September edged slightly lower to 71.2 percent from 71.4. There was also little impact in the bond market, as the yield on the two-year Treasury note rose one basis point to 1.21 percent following the report, while the yield on the ten-year fell one basis point to 2.47 percent.
Earlier in the week the Fed chose to leave interest rates unchanged, offering few hints about their future intentions. The Fed’s preferred measure of inflation, the core Personal Consumption Expenditure (PCE) deflator, rose only fractionally in December to 1.7 percent. The headline rate rose 0.2 to 1.6 percent, its highest level since September, 2014. And although the upward trend is encouraging for the Fed, the pace remains below its 2.0 percent long-term target, suggesting the Fed doesn’t need to be in a hurry to raise rates further.
Other evidence of economic acceleration last week included the strongest growth in consumer spending in three months in December, the strongest monthly growth in pending home sales in December since last April, the strongest growth in manufacturing in over two years as reported by the ISM for January, and a still healthy expansion in the service sector, although the pace cooled slightly from December. And factory orders rebounded nicely in December following a November decline.
Not every report last week showed improvement, suggesting that the recovery remains somewhat choppy. The Conference Board’s measure of consumer confidence edged slightly lower, although it remained at a level consistent with conditions before the financial crisis. Views regarding present conditions improved, while future expectations fell. Motor vehicle sales cooled modestly in January, although they remained at a healthy pace. However, reliance on incentives and rising inventory levels suggest further cooling ahead. And personal income growth in December was modest.
Earnings Expectations and Markets Continue to Move Higher
Stocks moved fractionally higher for the week. The S&P 500 added just 0.1 percent, bringing its gain for the year to 2.6 percent. The week’s strongest gains came on Friday after the president signed an executive order to initiative a review of the Dodd-Frank financial regulatory overhaul legislation. For the day, the S&P climbed 0.7 percent, while the financial sector XLF ETF added 2.0 percent, and the KBW bank ETF BKX added 2.2 percent.
The news on the corporate earnings front also continues to improve. According to Factset, with a little more than half of companies having reported, fourth quarter expectations continue to move higher. Aggregate results are now expected to reach 4.6 percent compared with the year earlier quarter. This is up from 4.2 percent last week, and 3.1 percent expected at the start of the quarter, attributable in large part to upward revisions in financials. And earlier concerns that a stronger dollar would be a headwind for earnings receded further last week. After rising 10 percent between mid-August and late December, the DXY dollar index has given back a third of those gains since, including another modest decline last week.