Weekly Market Highlights:
Domestic stock prices ended up gaining ground on the week. Stock prices advanced this week in the wake of the strong IPO of Twitter. The S&P 500 posted its largest loss in two months on Thursday as the government reported that GDP grew faster than expected in the third quarter, but rebounded on today’s stronger-than-expected jobs report. Twitter jumped 73 percent in its first day of trading.
Global markets were mixed for the week. World markets were modestly higher overall, with European markets gaining on the European Central Bank’s unexpected announcement that it would cut interest rates to a record low of 0.25%. Asian stocks were mostly lower on concerns that this week’s positive GDP report would result in the Federal Reserve (Fed) scaling back its quantitative easing program sooner than expected.
Treasury prices were lower this week. The yield on the benchmark 10-year U.S. Treasury climbed as today’s jobs report indicated the employment situation is on the mend.
Commodity indices were sharply lower on the week. All three major complexes – energy, metals and grains – declined on reports of increased supplies.
A Macro View:
In an indication that the employment situation seems to be improving, the Labor Department today reported that non-farm payrolls grew by 204,000 in October, and September’s gains were revised upward to 163,000. At the same time, the unemployment rate ticked upward slightly to 7.3% from 7.2% the prior month. The gains in October exceeded even economists’ most optimistic forecasts, as consensus estimates called for a gain of only 120,000 jobs in October. Today’s employment report follows yesterday’s better-than-expected third quarter estimate of GDP growth, which came in at 2.8%, providing further support that the economy may finally be showing long-awaited signs of acceleration.
Stock prices shrugged at the positive economic news, as most market indices were lower on the week. Investors seem to have interpreted the data as giving the Fed support to scale back its bond-purchase program (quantitative easing) sooner than anticipated, perhaps as early as next month. By tapering its bond purchases, the Fed would be ever-so-slightly reining in the aggressively accommodative monetary policy it has been following for much of the past five years. At some point the market needs to come to grips with the fact that the Fed will need to end its program, and perhaps the economy is at just such an inflection point where growth is self-sustaining.
Despite the market’s struggles to post gains on this week’s encouraging economic news, it is unlikely we have seen the top in stocks and that a material decline is imminent. Part of the reason is that even though stocks have posted strong gains so far this year (the S&P 500 and Nasdaq Composite are up more than 22% and 27%, respectively), the asset class still is attractive relative to bonds. Stock multiples have expanded, causing valuations to be stretched, but the positive outlook for the economy makes the environment more favorable for stocks than for bonds. We have already seen an uptick in real interest rates, and investor rotation from bonds to stocks is likely to accelerate. So, with economic growth projected to pick up next year, corporate profits should also be on the rise, which is a positive for stocks but a negative for bonds. In such an environment, despite the run-up in stocks this year, equities should be overweighted and bonds underweighted in a portfolio. Within the fixed income allocation, given that Treasury yields have declined 40 basis points or so from their peak, the outlook for the economy would warrant a shortening of duration and an underweight to Treasury securities.