It is easy, when news feeds are consumed with politics, for market-watchers to lose sight of what is important. Of course, with an administration and Congress determined to move in ways that favor business, their fate matters to the stock market and is partially responsible for the march to record highs, but it is not the main long-term driver of strength in stocks.
That honor still goes to low interest rates. A yield of below 2.5 percent on the 10 Year U.S. Treasury makes stocks more attractive, encourages growth-oriented investment, and is fueling consolidation in many industries. That is why, even with all the noise, investors should be focused on Friday’s jobs report.
Based on his words during the Senate confirmation hearings, no major policy shift can be expected when Jerome Powell takes over from Janet Yellen next year. If anything, Powell voiced the opinion that the labor market may still have more slack to give than many on the Fed Board of Governors think, and that that may allow for rates to stay lower for longer.
He also said that like Yellen, his decisions would be driven by data alone, so the data coming on Friday, and one number in particular, needs to be watched closely. I have said it before, but it bears saying again; at this stage, the most important data point in the jobs report is not non-farm payrolls or the unemployment rate, it is wage growth.
Powell, again like his predecessor, would prefer to keep rates low if possible. The unemployment rate is at an acceptable level and economic strength appears to be returning, but credit crises typically recover slowly, and the last one is no exception. We have been grinding through a recovery, and even with growth accelerating now, that recovery could still easily be derailed if the Fed acts too quickly.
The Fed, though, has a dual mandate. They are tasked with setting monetary policy to encourage full employment, but they must also try and avoid inflation. So far, there has been no sign of that as unemployment has fallen without putting any serious pressure on either wages or prices, but the last couple of jobs reports have revealed small upticks in the hourly wage rate. That is expected to continue on Friday, with wages showing a 2.4% increase, marginally higher than last month’s 2.2%.
That is an acceptable level, especially with PPI and CPI staying steady, but if the wage number comes in higher than expected traders will take it as an indication that a faster pace of rate hikes is imminent. That could easily derail stocks.
As I said, that needs to be watched, but that doesn’t mean that you should be wary of stocks early in the week. With the tax bill now looking almost certain to pass, it is likely to be a strong week, with the financial sector, big tech and manufacturing expected to lead the way.
In addition, as he showed by his comments this morning, President Trump’s response to the pressure coming from the Russia investigation is to point to the stock market as evidence of his success, which makes it likely that as that pressure increases he will do and say whatever he can to support the rally.
It is therefore quite possible that gains early in the week will be enough to offset any losses should the jobs report flash a warning signal, which means that overweight stocks is still the position to have. Should the reaction to the jobs report be negative, however, caution will be warranted.
The stock market’s strong recovery after Flynn’s court appearance and the fact that it is ignoring growing tension in North Korea and the Middle East suggest that taxes and low rates are driving gains, but Friday’s data could call one of those into question, so must be closely watched.