The Dow Jones Industrial Average topped 17,000 for the first time ever as jobs numbers last week were better than expected. But why should investors be so optimistic?
Bloomberg’s Oliver Renick had a fairly straightforward piece about the market gains last week:
A combination of economic recovery and central bank support that has steered the bull market into its sixth year came together again this week to power the Dow Jones Industrial Average over 17,000 (INDU) for the first time.
More than $200 billion was added to U.S. equities during the week as job creation surged beyond expectations in June while central banks in the U.S. and Europe repeated vows to support growth. Micron Technology Inc. and Netflix Inc. advanced at least 6.9 percent as the Russell 2000 (RTY)Index recovered nearly all its losses from a two-month selloff of Internet and small-cap shares. The Dow Jones Transportation Average (TRAN) rallied 1.5 percent to a record on the strength of global manufacturing.
The Dow rose 216.42 points, or 1.3 percent, to 17,068.26 for the holiday-shortened week. The Standard & Poor’s 500 Index climbed 1.3 percent to a record 1,985.44. The Russell 2000 jumped 1.6 percent, reaching an intraday high on July 1. The MSCI All-Country World Index increased 1.4 percent over four days to reach an all-time high.
Alexandra Scaggs had this story for The Wall Street Journal saying investors may begin to look for more out of companies:
The Dow Jones Industrial Average broke through 17000 for the first time ever last week, powered by an upbeat jobs report that was the latest in a string of strong U.S. economic indicators. That helped cement investors’ view that the weakness caused by severe weather in the first quarter was behind them.
Now, with stocks trading at their highest levels in seven years when compared with expected earnings, some investors say corporate revenue and profits need to accelerate to sustain the rally, especially as the Federal Reserve continues to pare back stimulus measures.
“People are going to want to see an improvement in earnings,” said Greg Luttrell, who manages $272 million in the J.P. Morgan Dynamic Growth Fund. “That would confirm that, yes…growth is on track.”
Mr. Luttrell is holding on to so-called growth stocks such as Facebook Inc., Priceline.com and Google Inc. that sold off steeply in March and April amid concerns that the shares were overvalued. Valuations of these stocks have fallen to reasonable levels, and they could start to look more attractive if those companies report strong earnings, he said.
The unofficial start to earnings season comes Tuesday, when aluminum producer Alcoa Inc. AA +0.88% reports second-quarter results. Alcoa’s earnings per share in the period are expected to double from the second quarter of 2013, according to consensus estimates from FactSet.
And it’s a good thing he’s not looking at financial stocks, since according to The Financial Times’ Camilla Hall U.S. banks will have a tough time when they report second quarter earnings this month:
Big US banks are expected to report dismal second-quarter earnings, with weakness in fixed-income trading and mortgage banking overshadowing an increase in lending to companies and consumers.
Wells Fargo will start the earnings season on Friday, followed by Citigroup, Goldman Sachs, JPMorgan Chase, Bank of America, and Morgan Stanley which will report the following week. Of the six big banks, only Morgan Stanley is forecast to post a rise in net income, according to analyst estimates compiled by Bloomberg.
Banks including Citi and JPMorgan have already warned of another weak quarter for fixed income trading. Citi’s chief financial officer said at the end of May that trading revenue could drop as much as 25 per cent in the second quarter from a year ago. JPMorgan has said trading revenue could decline about 20 per cent.
While that’s just one sector, but Peter Coy wrote for Bloomberg Businessweek that besides corporate earnings, investors need to watch out for inflation:
The strongest job growth since the recession is indisputably good news. On top of the employment gains, average hourly earnings rose 0.2 percent in June and 2 percent over the past year. That’s a healthy development because it gives workers the money they need to spend, helping both them and the economy. “My own expectation is that as the labor market begins to tighten, we will see wage growth pick up some,” Federal Reserve Chair Janet Yellen told reporters last month. Yellen said believes there is still plenty of slack in the labor market and no risk of inflation, so there’s no rush to start tightening monetary conditions.
Even long-term joblessness, which has been a sore point in this expansion, is easing. The number of long-term unemployed fell to 3.1 million, and their share of all jobless fell to 32.8 percent, the lowest since June 2009. The share of working-age people in the labor force—i.e., the participation rate—stayed little changed at 62.8 percent.
But there’s a dark cloud inside every silver lining: To inflation-phobes, a rebound in wage growth is a warning sign of inflation ahead. The fear is that the deep 2007-09 recession knocked many people out of the labor force permanently, so there’s not as much slack in the job market as there appears to be. On top of that, the inflation-worriers say, a lack of investment in labor-saving machinery and software means that workers’ productivity isn’t growing much, putting further pressure on the labor market.
The jobs announcement was undisputed good news, sending many who have been sitting on the sidelines into the market. But how long that will last is another question since there are many other areas of the economy that don’t seem so robust. The savvy money managers will take profits now, since it’s hard to see how long these good times will last.
