The U.S. stock market is taking manifest destiny to new heights. With several measures suggesting inflation is looming, investors saw the glass half full at every turn this week, seemingly betting that the big-picture puzzle will fall into place.
The declining dollar and convictions that oil prices have peaked helped stocks march higher this week, despite strong economic data that belie hopes the
will refrain from hiking rates at its June FOMC meeting. Maybe investors have more faith in the Fed and new Chairman Ben Bernanke than pundits believe, or more than seems justified, given Bernanke's curious "communication strategy" unveiled this week.
Even as the Russell 2000 and other broad measures hit all-time highs, large-cap stock indices grabbed the headlines this week. The
Dow Jones Industrial Average
closed up 1.22% Friday at a new six-year high of 11,577, only 145 points away from its 11,722 all-time high hit Jan. 14, 2000. For the week, the Dow rose 1.9%, led by
, and despite more weakness in
gained 1.2% for the week after rising 1% Friday to a new five-year high at 1325, solidly past technical resistance at 1310, its closing level last Friday. The
advanced 0.9% for the week after closing up 0.8% to 2342 on Friday.
The Dow Jones Transportation Average reached a record high of 4,958 Friday, led by components
, and rose 6.3% for the week as crude prices fell.
Glass Half Full
The Labor Department's report that nonfarm payrolls gained 138,000 in April gave the stock market a nice pre-weekend tailwind, as traders seemed to sidestep the higher-than-expected increase in hourly wages -- a sign of burgeoning wage inflation.
From the point of view of the Fed and stock market, the payrolls half of the report is good news. "They're all hoping that job growth falls to138,000," said Ethan Harris, chief economist at Lehman Brothers.
If this is the beginning of a slowdown in employment growth, then "we're having a very nice soft landing in the job market," he says. "That is the 'Goldilocks economy.' "
The stock market is certainly betting that the Fed is going to pause after the FOMC meeting next week -- a two-day affair starting Tuesday -- at which it is expected to raise its fed funds rate to 5%. Belief in a pause after May 10 congealed this week after Bernanke felt compelled to call off the markets' excitement over the concept of the Fed's tightening being "one and done." Upon
Maria Bartiromo's reporting of the news Monday afternoon (more than 36 hours after the actual discussion took place), a reactionary selloff took place. But that proved to be a temporary hiccup and markets forged ahead.
On the back of the payrolls data, odds the Fed will raise its fed funds rate in June have fallen to 34% from 46% Thursday, according to Miller Tabak.
Perhaps the stock market's insistence on a rally represents traders' hoping manifest destiny will work with the Fed as well -- that it will be "done" even though it is taking pains to tell us it is just being data-dependent.
"It is perfectly conceivable that the Fed is done on May 10 but will go out of its way to tell us that a pause does not mean an end," said David Rosenberg, economist at Merrill Lynch. "As the 1995 and 2000 events suggest, it may be the end even if the Fed and the majority of economists don't believe that to be the case."
Rosenberg asserts the Fed telegraphed that it wasn't done in 1995 and 2000, but in fact it was done. Confused yet?
The glass-half-full view ignores many red flags, however. Hourly wages increased 0.5% in the month of April, the third consecutive monthly increase, and up by the largest increase since 2001 on a year-over-year basis. In addition, Thursday's productivity report showed unit labor costs increased a higher-than expected 2.5% as well. Only last Friday's employment cost index was softer, with an increase of 0.6% for the first quarter.
"It's tight," Harris says of the labor market.
Everything is tight, but is the Fed tight enough? If the economy is slowing but inflation is mounting, the Fed finds itself in a pickle. Both manufacturing and nonmanufacturing reports from the Institute of Supply Management were strong this week, as were retail sales, productivity gains and mortgage applications, but initial jobless claims for the week ended April 29 were the highest this year at 322,000.
More broadly, the tectonic plates are smoldering. The market is running at the top end of the Fed's inflation comfort zone of 2% core personal consumer expenditures index; unemployment at 4.7% is at a level associated with inflation pressures; 4.8% GDP growth is above-trend, which puts pressure on employment and capacity. The last is the uncertainty about the effectiveness of the Fed's tightening cycle thus far, given the lag effect. Still, high commodity prices also indicate that the inflation scales may be tipping, regardless of bullish sentiment in the stock market.
To add to the contra-indicator theme of the week, the markets dealt with mixed messages from central bankers abroad as well. Japan's Finance Minister Sadakazu Tanigaki told reporters Wednesday in India that while he wants to correct global imbalances, "excessive and steep movements are undesirable." It is too bad for him that traders weren't listening.
Indeed, the dollar continued to drop Friday, ending at 112.43 yen vs. 116.65 last Friday while the euro rose $1.27, its highest level since last May.
payrolls was the worst of both worlds (slower growth and rising inflationary threats)," says Ashraf Laidi, chief currency analyst at MG Financial, adding that the weak payroll added fuel to the dollar sell off that has been under way all week
Oil experienced a sharp selloff at the end of the week as well, another positive factor for stocks, or so the talking heads say. Crude is still over $70 a barrel (at $70.19 Friday), but the market seems to have absorbed the notion that it is not a problem. "As long as oil prices go up gradually, we can live with them," said David Wyss, chief economist at Standard & Poor's. Oil closed at $71.57 the previous Friday.
To kick off the topsy-turvy bullish tone of the week, two notoriously cautious voices in the market turned slightly more optimistic. Merrill Lynch's Richard Bernstein turned up his allocation to stocks, though acknowledged it wasn't exactly because he felt as strongly about stocks as he did about moving out of bonds and into cash. And Morgan Stanley economist Stephen Roach wrote an optimistic piece about the global economy. Some took this as an indication that the top is near. Indeed it is, only 145 points away for Mr. Dow Jones.
In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click
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