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U.S. stocks hit all-time high as unemployment reaches decade low

Brian Nick, Chief Investment Strategist, TIAA Investments


May 5, 2017

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Quote of the week

“There is no pleasure in having nothing to do; the fun is having lots to do and not doing it.” — Andrew Jackson

The Lead Story: A “that’s more like it” jobs report

Another 211,000 people were added to the nation’s payrolls in April, more than we’d anticipated. Even with March’s downward revision (from 98,000 to 79,000), average job gains remained a healthy 170,000 per month over the past 12 months, versus 205,000 and 229,000 for the 12-month periods ended April 2016 and April 2015, respectively.

This trend tells us that while job creation is now outstripping the number of new workers, the pace of expansion is slowing. Within the next year or two, we expect further slowing in monthly gains to around 80,000 to 100,000, a level commensurate with the growth in the working age population.

Brian Nick, Chief Investment Strategist, TIAA Investments

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On a less positive note, wage growth softened in April, and while the unemployment rate dropped to 4.4%—the lowest level since 2000—this was due to a shrinking labor force. Even without broad-based wage pressures, though, the Federal Reserve will take enough from this report to raise interest rates next month, barring some unforeseen negative event. Market-implied odds of a rate hike, which were around 65% before the Fed’s May 2-3 meeting, are now 100%.

In other news: Vexed by the VIX?

Heated rhetoric from North Korea. Simmering tensions in Syria. Slower U.S. economic growth. One might expect these potentially worrisome events to inject anxiety into U.S. equity markets. Instead, investors haven’t been this relaxed since 2007, as the VIX, or “fear” gauge, hit a 10-year low on May 1, and the S&P 500 closed the week at an all-time high just shy of 2,400.

Why the drop in volatility? First, day-to-day market swings have been unusually small. The S&P 500 has moved up or down by 1% or more in a single session just three times this year—far below historical norms. Moreover, investors seem not to see any singular, clearly identifiable risks warranting a heightened state of anxiety. (In contrast, the VIX spiked just prior to last June’s Brexit vote, the U.S. presidential elections, and the opening round of the French election.) In short, we think the market is essentially in “wait and see” mode.

We expect U.S. stocks to be largely range-bound for the remainder of 2017. The run-up in valuations since November has already priced in healthy corporate earnings growth and delivery of business-friendly policies from President Donald Trump and Congress. On the other hand, lofty valuations are not good predictors of equity market corrections. Corporate earnings should “grow into” this market, which means valuations can come down without prices falling.

Moreover, we expect solid economic growth in the U.S. and around the world over the balance of the year. The Fed gave a clean bill of health to the U.S. economy in its most recent policy statement. While keeping the fed funds rate unchanged, policymakers noted that they believe the economy’s first-quarter growth slowdown and recent softening of inflationary pressures to be “transitory.”

In fixed-income markets, U.S. Treasury yields rose modestly during the week, reflecting firmer expectations for gradual Fed tightening this year. (Yield and price move in opposite directions.) The yield on the bellwether 10-year note ended the week at 2.35%. Speculation that the Trump administration might issue 50- and 100-year Treasury bonds also contributed to higher yields on longer-dated issues. 

Rising yields contributed to negative returns for spread sectors. By posting a loss on May 4, high-yield corporate bonds ended an 11-day winning streak. The asset class, which consists of about 20% energy debt, has thus far been able to weather oil’s recent price decline. In the near term, a backdrop of better economic growth and modest inflation should provide a measure of relative calm for fixed-income investors.

Current updates to the week’s market results are available here.

Below the fold: Europe’s economy and equity markets roll on

Eurozone economic data releases continue to confirm that region’s recovery. Among the most recent reports:

  • GDP grew by 0.5% per cent in the first quarter (+1.8% year-on-year), according to Eurostat’s preliminary report, about the same as the U.S. economy.
  • Manufacturing and service-sector activity hit a six-year high in April, with Markit’s  final Eurozone Purchasing Managers’ Index registering 56.8. (Readings above 50 indicate expansion.)
  • Inflation rebounded in April to a 1.9% annual rate, within the European Central Bank’s target of below, but close to, 2%.
  • Retail sales rose in March for the third consecutive month.

Europe’s STOXX 600 Index has benefited from the one-two punch of robust data and excellent corporate earnings, which have topped forecasts by an average of 10% this quarter. Banks have done even better, with “beats” averaging 21%. For the week, the STOXX 600 rose 2.8% (in U.S. dollar terms), boosting its year-to-date gain to 15.6%.  At the start of the last Fed tightening cycle in 2004-2006 (when the European Central Bank was still easing or pausing), European stocks significantly outperformed U.S. shares. While past results cannot guarantee future returns, we could see an encore performance.

U.S. data, meanwhile, was mixed. The week’s releases included:

  • The Citi Surprise Index plunged during the week. This index gauges the extent to which economic data releases diverge from consensus forecasts; rising index levels indicate more upside surprises.  
  • Inflation, as measured by the Fed’s preferred inflation barometer (the PCE Index), fell 0.2% in March, reducing its year-over-year increase to 1.8%. The “core” PCE Index, which excludes food and energy costs, also ticked down in March, by 0.1%, and has risen only 1.6% in the past year.
  • Manufacturing activity remained in expansion territory but slipped to 54.8 in April, according to the index published by the Institute for Supply Management (ISM). 
  • U.S. service-sector growth, however, exceeded forecasts, with the ISM index jumping to 57.5.

Against this mixed batch of reports, the S&P 500 gained 0.6% for the week. The index has edged up only slightly since hitting an all-time high on March 1.

Back page: Ch-ch-ch-changes are taking place in the labor force

“Time may change me, but I can’t trace time.” David Bowie’s words struck me as I recently drove by Maryland’s first cotton mill, built in 1810. Once used to make clipper sails, tents, and men’s clothing, the property was sold to developers in 1989. Now, it houses the quintessential American success story, Starbucks. What a manifestation of a changing America, and the labor force is changing along with it.

If Starbucks is hiring these days, it’s an outlier among retailers. According to the Bureau of Labor Statistics (BLS), the retail sector has shed nearly 50,000 jobs in the past 90 days. The April employment report showed gains of 21,000 in construction, manufacturing, and mining and logging. But moving forward, a smaller percentage of Americans will be working in these goods-producing fields. The increase in service-based professions will more than offset these numerical losses, however. And the biggest opportunities for new employment continue to be in health-care and social assistance.

Of course, it’s not  realistic to think that manufacturing workers will quickly shift their skill set to take on other professions. And even those who do may have to accept lower pay. Average compensation in the five fastest-growing U.S. occupations is about 40% lower than the average wage in manufacturing.