Last Friday’s job report helped vault stocks into record territory. At one point, the Dow Industrials crossed the 15,000 mark and the broader S&P 500 settled above 1,600 for the first time. Some of the positives seen in the April employment situation report included a decline in the civilian unemployment rate to 7.5 percent, its lowest level since December, 2008, and upward revisions to payrolls for February and March. Traders viewed this news as an indication that the economy is healthier than was previously believed, trumping numerous other reports of late that have fallen well short of expectations. It was also viewed as a sign that the federal government’s sequester, which began in March, will have less of an adverse impact on the economy than was feared.
There’s an old adage on Wall Street that says the most bullish thing the market can do is make new highs. But there’s ample reason to be skeptical of the message from the major averages moving into uncharted territory, especially as bond yields are scraping along near their lowest levels of the year (and not far from record lows either), a unique divergence if ever there was one.We have misgivings, however, that the health of the economy may not be improving as much as many investors concluded from the jobs report: for starters, unfortunately, most of the upward revisions in the payrolls numbers occurred in February, prior to the sequester. While the impact of the austerity is likely baked into economic expectations, we’ll remain circumspect while awaiting further signs that consumers remain eager to spend.
And while more people were hired than expected in April, the pace of job creation remains quite tepid and the jobs are concentrated in low-paying, service sector careers. At the current rate, it will take many more years to bring the overall unemployment rate down to pre-recession levels. We therefore will want additional indications that the improving picture will last.
Indeed, what’s moving stocks is not so much improving economic prospects as the belief that the Federal Reserve will continue its colossal $85 billion in monthly asset purchases indefinitely, a belief reinforced by the latest Federal Open Market Committee policy statement, released last week. This bond buying is compelling investors to allocate more funds to equities, regardless of underlying conditions. And the U.S. has plenty of company in this regard.
Pressure is mounting in Europe to step back from the austerity measures that have mired that continent in a self-reinforcing contraction. They, too, will continue to inject liquidity like never before. The European Central Bank is even weighing imposing sub-zero bank deposit rates to spur spending. And Japan has taken the asset-buying binge to another level altogether. Even China, while still expanding at an enviable rate, is experiencing a bit of a slowdown, with its service sector growth dropping to its lowest level in nearly two years. This opens the door to easier Chinese monetary policy as well.
As for the American economy, our models point to continued expansion, albeit at only a very moderate pace – much like we’ve experienced in recent months. The problem is that growth below 2 percent leaves the economy in danger of easily sliding into recession, taking stocks south with it.
So while we view the current stock market vigilantly, alert for indications that a significant downturn is in the offing, we also want to stress the need to remain invested, lest you miss out on a potentially significant advance, even if it is momentum based and not one rooted in strong underlying fundamentals.
You can protect yourself by shunning the so-called “defensive” shares that have catapulted to seldom-seen high valuation levels. Instead, focus on shares with well-defined growth prospects that are trading at reasonable prices (i.e. stocks with low PEG ratios), such as those in our Growth Portfolio. Reasonably priced income-oriented stocks of companies with dividends that are amply covered by cash flow are another good bet in this market. Here again we want to stress that attention should be paid to valuations rather than reaching for the highest yields.Investing is seldom an easy endeavor. And today’s market is unlike any before: There are ample opportunities yet it is nevertheless fraught with risks.