Good News for the Economy is Bad for Stocks

In the topsy-turvy, bizarro land of Wall Street, sometimes a bit of good news about the economy can be bad news for investors. The economy added 200,000 jobs in January, higher than last year’s monthly average of about 170,000. The unemployment rate remained at a 17-year of 4.1 percent; and perhaps most encouraging, annual hourly earnings jumped by 2.9 percent, the fastest pace since the recession. (The figure does not include special one-time, tax-related bonuses that have thus far helped about two percent of workers.)

If the report was so good, why did the stock market drop? The answer appears to be that higher wages could be an early warning that the economy is heating up, which could lead to inflation. In that case, the Federal Reserve would have to increase interest rates faster than currently anticipated. According to the December projections by Fed officials, they expected three quarter-point hikes in 2018.

Inflation still remains really low and for most workers, wages will likely rise faster than prices. For companies, rock-bottom rates have allowed them to borrow money cheaply and have helped fuel the second longest bull market on record. But if it becomes harder for firms to earn more in the future—especially as valuations and profits get stretched, investors may finally be tempted to seek the relative safety of bonds. That’s why stock indexes had their worst week in more than two years.

Meanwhile, the yield on the benchmark 10-year Treasury note rose to 2.854 percent, the highest intraday level since January 2014. Now that might seem pretty rotten for neophyte investors who have enjoyed a near nine-year stock market bull-run. Indeed, the underlying data suggest that stocks are better performers than bonds. According to Capital Economics, “Since 1900, average annual real returns from the S&P Composite and 10-year Treasuries have been roughly 6.5 percent and 1.6 percent, respectively. What’s more, the average return from US equities has exceeded that from US bonds in all but two decades [the 1930s and the 2000s].”

So far, so good for this decade -- the average annual real return from US equities exceeded that from 10-year Treasuries by nearly ten percentage points between 2010 and 2017. But just because something has not happened, does not mean something will not happen. And you just might like the comfort of that diversified portfolio when that time eventually does come.

One last question: If we’re making more money, why are we saving less? According to the Commerce Department, the household saving rate fell to a 12-year low of 2.4 percent of disposable income in December. While it is true that Americans appear to be on a firmer financial footing than they were back in September 2005, the CFP in me wants to emphasize that if you are going to get a tax refund or see higher take home pay as a result of the change in tax law, please try to save some of that extra dough!

MARKETS: It was the worst week for since the near-6 percent decline in the first full week of 2016, which led to the last correction, when the S&P 500 10.5 percent on 2/11/2016. And before you get too anxious about 600-point Dow drops, remember that the index is at a much higher level than it was in 2008 (the last time the index saw a nasty 600-point drop in the Dow), when a 679-point drop amounted to a 7.3 percent, versus the 2.5 percent decline on Friday.

• DJIA: 25,521, down 4.1% on week, up 3.2% YTD
• S&P 500: 2762, down 3.9% on week, up 3.3% YTD
• NASDAQ: 7241, down 3.5% on week, up 4.9% YTD
• Russell 2000: 1547, down 3.8% on week, up 0.8% YTD
• 10-Year Treasury yield: 2.837% from 2.662% a week ago
• AAA Nat'l avg. for gallon of reg. gas: $2.60 (from $2.58 week ago, $2.28 year ago)