The major market indices finished the week moderately higher on further signs the economic recovery remains on the mend and fading concerns over a debt contagion in Europe. Seasonal influences were also likely at work as December historically has been the best overall month for market performance.
After correcting by just over 4% from the highs reached on Nov. 5, the rebound over the course of last week likely indicates that the correction has probably run its course. Last week's gains may also be partially explained by the growing expectations that the Bush tax cuts will likely be extended for all wage earners.
This could act as a catalyst for businesses to start dipping into their record cash hoards and resume hiring. As pointed out in these missives in the past, businesses have accumulated almost US$2 trillion in cash on their balance sheets and have been reluctant to spend and/or add to their payrolls until they get further clarity on the policy, regulatory and economic fronts.
Payroll report – disappointing
On Friday the U.S. Labor Department reported that nonfarm payrolls during the month of November rose by only 39K, well below the 150K expected by economists. Private payrolls, which filter out the distortion from government hiring/firing, rose by only 50K; also well short of the 160K gain expected by economists. The unemployment rate ticked up to 9.8% (from 9.6% last month). On a positive note, October nonfarm payrolls were upwardly revised by 38K and temporary employment in November expanded by 40K, a potential precursor to more permanent hiring down the road. In addition, despite the punk number in November, private payrolls have grown by 1.17 million since the start of this year.
The report, however, was clearly disappointing and will likely temper some of the recent enthusiasm surrounding the economic recovery. While other economic data has shown signs of life, the employment data was a sobering reality check that the road to recovery still faces hurdles. The unemployment rate, now at the highest level since April and the first uptick since August, has been above the 9% mark for 19 months and has exceeded the previous record of 18 months that occurred in the early 1982 through late 1983 period.
| Index | Closing Price 12/3/2010 |
Week Ending 12/3/2010 |
Year to date through 11/12/2010 |
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 |
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| Dow Jones Industrial Average | 11382.09 | 2.62% | 9.15% | ||
| Wilshire 5000 Total Market | 12758.63 | 2.97% | 11.70% | ||
| S&P 500 | 1224.71 | 2.97% | 9.83% | ||
| NASDAQ Composite | 2591.46 | 2.24% | 14.20% | ||
| S&P/TSX Composite | 13178.95 | 2.22% | 12.20% | ||
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Other economic data – encouraging
Despite the disappointing employment data--although not to downplay it either--other economic data last week showed encouraging progress. Both the Institute for Supply Management's (ISM) manufacturing and non-manufacturing (services) indexes remained solidly in expansion territory. The manufacturing index has been above 50 (the dividing line between expansion and contraction) for 16 months while the non-manufacturing index has been above 50 for 11 consecutive months. Other encouraging economic data included the 10.4% surge in pending home sales. The gain was the biggest monthly increase since at least 2001 when the National Association of Realtors began keeping records.
Retail sales also appear to be on the mend. Last week the International Council for Shopping Centers (ICSC) reported that sales at stores open at least one year rose by 5.8% in November, the 12th consecutive gain and the biggest gain in eight months. The report sheds a favourable light on the holiday season, especially considering the 0.2% drop in November of last year and 7.7% decline in November 2008. The uptick in sales likely reflects some pent up demand following an extended period of belt tightening. More importantly, however, the uptick in sales may be indicative of growing consumer confidence. With consumer spending representing more than two-thirds of economic growth, a more confident consumer would be a welcome development.
Beige Book
The Beige Book report, which provides anecdotal information collected by the 12 Federal Reserve district banks, showed the U.S. economy continued to improve. Manufacturing activity continued to expand in almost all districts, consumer spending was generally positive, and expectations for holiday shopping season were generally upbeat. The report also underscored that the housing market remains depressed. Hiring activity showed improvement across most districts but employers appeared to be waiting for clearer signals of economic expansion before adding to payrolls.
Laying the ground work for 2011 - initial thoughts
The recent string of improving economic data likely provides confirmation that a double-dip recession is no longer in the cards. In addition, signs of progress in manufacturing, employment and consumption likely set the stage for a solid lead-in to 2011. While the pace of growth will be watched very closely, economic momentum seems to be picking up steam and may result in an upside surprise in expected growth.
Improving economic conditions coupled with abundant amounts of liquidity, attractive valuation, an investor-friendly Federal Reserve, a low (and likely to stay that way) interest rate environment all provide a favourable backdrop for the additional upside in the equity markets. Consensus expectations for 2011 S&P 500 earnings have been trending higher and according to Bloomberg currently stand at approximately US$96.00. If the market is able to achieve this level of earnings and the Price to Earnings (P/E) multiple is able to expand to 14.0 or 14.5 (versus the current forward multiple of 12.5 times) the S&P 500 could trend toward the 1350 to 1400 level sometime over the next 12 months.
While economic conditions are expected to show gradual improvement, the Fed is likely to remain on hold for the course of the year. The Fed's major concern remains the lack of overall inflation in the economy. While core inflation (excluding food and energy) remains benign and inflation overall is a lagging indicator, there appears to be ample reason for the Fed to maintain a loose policy for the foreseeable future.
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