After eight straight weeks of advances, the market cooled off a bit starting the day after Thanksgiving through the first four days of last week. These five consecutive lower closes were the longest such streak since September, and resulted in the S&P undergoing a modest 1.2 percent downside correction. This all came to a dramatic end last Friday after the release of the November non-farm payroll report, and to make matters even more satisfying to market bulls, the S&P attained a new all-time closing high on Monday at 1808.
The downside pressure had continued for the first four days last week as various economic reports led investors to follow the old “good news is bad news” syndrome as the perception was that if the economy was showing signs of improvement, this meant that the Federal Reserve had more reasons to begin tapering the current $85 billion a month stimulus program that has done so much to help the stock market attain record highs this year.
This series of better reports began on Wednesday with the estimate from ADP for last Friday’s jobs report. They predicted that the economy would add 215,000 new positions, much higher than the official consensus estimate of 185,000. The October trade deficit narrowed to $40 billion on record U.S. exports, which could mean that economies in other parts of the world were also doing well. The September/ October new home sales report, which was combined due to the partial federal government shutdown in early October, showed an astounding 25.4 percent gain, which was the most in more than 33 years. The Fed Beige Book of economic conditions in various parts of the country mentioned that there was “modest to moderate” growth led by strong manufacturing activity.
On Thursday, investors were treated to more good news about the economy and reacted by selling stocks off further, as weekly jobless claims declined by 23,000 down to 298,000, the lowest since early September. In addition, the final estimate for third-quarter G.D.P. showed a gain of 3.6 percent from the prior estimate of 2.8 percent, but this was due to the largest inventory increase since 1998. Nevertheless, the overall figure was the highest since the first quarter of 2012.
Investors might have over-reacted to the downside by selling off stocks for the fourth day in a row as a result of the latter report, as this inventory buildup accounted for 1.7 percentage points of the advance, the largest such contribution since the fourth quarter of 2011. On the other hand, consumer spending, which constitutes around 70 percent of U.S. economic activity, was revised downward to an increase of only 1.4 percent, which was the lowest such total since the fourth quarter of 2009. The exuberance that the economy was doing better and that the Fed was going to push the tapering button sooner rather than later was downplayed by comments from the Atlanta Fed President who remarked that “I am not prepared to interpret the revised third-quarter number as an indication that the economy is on a much stronger track as I think that we’re still on that relatively moderate growth track.”
With the market down for five straight days, investors awaited the release of the November jobs report, which showed that the economy added 203,000 positions last month and that the unemployment rate declined to a five-year low of 7 percent. This drop in the jobless rate to its lowest level since November 2008 was due to some federal employees who were counted as unemployed in October returning to work after that 16-day partial federal government shutdown. Manufacturing payrolls rose by 27,000, their fourth straight month of gains, and construction jobs increased by 17,000. Retail employment also increased by adding 22,000 jobs in addition to the 46,000 from the prior month.
The September and October totals were revised upward to show an additional 8,000 jobs had been created in those months as well. Average hourly earnings and the length of the workweek increased also. This improving jobs market was probably the reason why the preliminary December U. of Michigan Consumer Sentiment Survey rose to its highest level since July and October personal spending rose by more than expected as well.
But surprise, surprise — instead of selling off as it had done in reaction to other recent better-than-expected economic reports, the market on Friday put in its best showing in a while, as the Dow had its strongest day since October 16, a gain of almost 200 points, and the S&P advanced by the most since November 8. As a result, the latter ended the week with a net decline of less than a point, undoing the damage of the prior five lower days.
There were a number of reasons to explain the market’s latest upside explosion, the first of which was that it proved my long-held conviction that it is always better for stocks or an individual equity to go into a major event (i.e., an earnings report for an individual company) in a weakened position because the bar for success is now lowered due to the fact that the potential negative reaction has already been discounted to a large extent. This means that those who were positioned the wrong way have to scramble to cover their now incorrect positions, which adds to the upside. More importantly, from a fundamental standpoint, Friday’s strong jobs report shows that the market is finally beginning to feel comfortable with the fact that Fed tapering is now going to be due to a better economy, which should ultimately be longer-term supportive for equities.
The fact that the S&P then went on to achieve a new record high on Monday illustrates what a remarkable year this has been in the sense that in addition to the market putting in its best yearly showing in more than 10 years with a 26.8 percent advance, the largest downside correction we have seen in 2013 was the 5.8 percent late May to late June decline as a result of Fed Chairman Bernanke first suggesting that the Fed was going to taper the stimulus at some point. The average intra-year decline for stocks since 1980 has been 14.7 percent and one can say that so far this has been the least nerve-wracking year for equities since 1995, which saw a 34 percent increase without as much as a 3 percent correction.
Donald Selkin is the Chief Market Strategist at National Securities in New York, a veteran in the securities industry for 36 years who is widely quoted in the financial media.
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