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The S&P 500 had another positive week as it was up 0.41%. Its Friday close was a new record high, bringing its year to date performance to up 7.17%. The market was led by Apple which reached a new record high. It’s market cap is $773.85 billion which means it has an outsized effect on whatever index it is in.
The market has not had a 5% correction this year. It continued its stagnant action this week as it hasn’t moved 0.2% in 8 days. As you can see from the chart below, this is the longest streak without a 0.2% move since 1964. The longest ever streak is 10 days. The VIX has been stuck between 10 and 11 this week which is a historically low price.
However the positive action in the markets has not been supported by economic reports.The Citi Economic Surprise index has fallen to -18.20 as you can see in the chart below.
The surprise index looks at actual economic results compared to expectations. When most economic results are missing expectations, the index turns negative. The index isn’t as negative as it was in early 2016, but it’s still showing that economic reports aren’t beating economists’ projections. This index was positive during the first quarter even though GDP growth was only 0.7% because it includes survey reports. Only hard data is included in GDP. As you can see, the European economic data is fairing much better than American data. As of April, the IMF was projecting 2.3% GDP growth for the U.S. and 1.7% growth for the Eurozone. Looking at the surprise index, those numbers may end up flipping.
The biggest economic news of the week came from the labor market as the April ADP private sector payrolls and BLS non-farm payrolls reports were released. The ADP report showed continued strength from last month as the winter storm didn’t hurt the report in March like it did the BLS report. As you can see in the chart below, 177,000 private sector jobs were created. This is about 12,000 below the twelve-month average gain, but it’s still a strong number.
The ADP report breaks down the job gains by the size of the employer. Small sized businesses with 1-49 employees increased their payrolls by 61,000. Midsized firms which have 50-499 employees had the best month as they improved payrolls by 78,000. Large firms with 500 or more employees had the weakest jobs gains as their payrolls improved by 38,000. The most important subset is small businesses because they create about 2/3rds of the jobs in the economy. The chart below breaks down the historical job growth by each business size. As you can see, large firms have accelerated above firms with 1-19 employees. The latest results are positive because the businesses with 20-49 employees have grown quicker than the largest businesses.
Even though investment in oil has rebounded along with the price in Q1, the April ADP report showed goods producing businesses only adding 12,000 jobs while the services businesses added 165,000 jobs. Natural resources and mining only added 3,000 jobs even with the added oil investment.
The situation may get worse in the next few months for that industry because oil prices have been sinking lately. WTI has fallen from the low $50s to the mid $40s. The most important factor which will determine oil prices for the next few months is the OPEC meeting on May 25th where the oil ministers will decide whether to continue production cuts, make the cuts deeper, or end the cuts. The best industry in the service sector was professional and business which is good news because they’re typically higher paying jobs than the other industries.
As was mentioned the BLS report in March was very weak because of the snowstorm. The March number was revised lower from 98,000 to 79,000. The Fed claimed the weakness was transitory in its May meeting which set up a June hike by 25 basis points. The Fed ended up being correct because the April report showed 211,000 job gains as you can see in the chart below. This beat estimates for 190,000 jobs added.
The details of the report were mostly good. The unemployment rate fell from 4.5% to 4.4% and the underemployment rate fell from 8.9% to 8.6%. A weak spot was the labor participation rate which ticked up from 62.9% to 63.0%. The number of Americans not in the labor force increased 162,000 to 94.375 million. Hourly wage growth met expectations for 0.3% on a month over month basis, but misses expectation for 2.7% growth on a year over year basis as it came in at 2.5%. It’s important to not get too caught up in the weakness in hourly wage growth, which can be seen in the second chart below, because average weekly hours worked increased from 34.3 to 34.4. Take home pay is what impacts consumer spending. It doesn’t matter whether it comes from working more or getting a raise. As you can see from the first chart below, because of this increase in hours worked, weekly earnings growth was 2.6% which was the fastest growth since December 2016.
As was mentioned, the Fed had its meeting this past week. It hinted that it would raise rates in June which would continue its path towards raising rates 3 times this year, with the third hike being in September. The Fed claimed the economic weakness seen in the Q1 GDP report was transitory. As you can see from the chart below, the market believed what the Fed stated as it is forecasting with 78.5% certainty that the Fed will raise rates on June 14th.
As we have detailed previously, the continued rise in the stock market is not being supported by economic results. Part of the optimism may have been attributed to the passing of the healthcare act through the House of Representatives, but this in no way guarantees its passage through the Senate, which has already indicated its intent to rewrite the bill. The Fed’s willingness to continue raising rates despite poor economic results suggests that the same mistakes are being made as were made prior to 2008. The increase in the Fed funds rates increases the costs of borrowing, which for an over leveraged economy decreases consumption and stagnates the economy even further.
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