U.S. equities dropped on Friday with the S&P 500 and the Dow erasing over 1 percent despite a strong December jobs report that solidly beat estimates with 292,000 non-farm payroll jobs added to the economy alongside higher job revisions for October and November.
Following the release of the strong jobs report early on Friday, the U.S. dollar rose against a basket of foreign currencies.
The Federal Reserve pays close attention to the U.S. labor market when deciding about whether the economy is in good enough shape to sustain an interest rate hike.
Last month, central bankers at the Federal Reserve decided to raise interest rates at the Federal Reserve for the first time since June 2006 when it increased the federal funds rate to .50 from near zero percent at .25, a level that has remained in place since December 2008.
Over the past 3 months, the U.S. economy has added an average of 284,000 non-farm payroll jobs per month and the unemployment level is at 5 percent, a 7 1/2 year low.
A robust U.S. labor market, pushed higher by a strong December employment report increases the odds for the Federal Reserve raising interest rates at their March meeting.
On Friday, the market appeared to be aware of that interest rate possibility when stock indexes declined over 1 percent despite an impressive December employment report.
Another factor that central bankers at the Federal Reserve pay attention to and examine when considering to raise interest rates is U.S. inflation.
Since crude oil has been in retreat mode in recent weeks, lower energy prices push inflation prices lower and away from the Fed’s 2 percent inflation target.
Low inflation levels could lead central bankers at the Fed Reserve to delay raising rates.
So far in January the Dow is off to its worst start since the index was created in the 1920’s as the 7 year U.S. bull market grinds to a halt in the midst of a shaky global market with China’s quarterly GDP falling to a level not seen since 1990 and expectations of 4 interest rate hikes in 2016 based on recent dot plot projections from the Federal Reserve.
Weak economic growth in China along with a decision by China’s central bank to devalue the yuan, and crude oil prices that have fell another 10 percent since January 1st, were some of the catalysts that led investors to take risk off the table last week and sell equities.
Some economists are not convinced that the Federal Reserve will raise interest rates four times in 2016.
“We now look for one less rate hike in 2016, as the Fed delivers a snail’s pace of normalization,” said Ellen Zentner, chief U.S. economist for Morgan Stanley.
“If growth does not appear to be exceeding potential, and inflation isn’t moving to 2 percent, then further hikes won’t be called for” Zentner said in Morgan Stanley’s 2016 outlook.
Zentner believes that the U.S. consumer will boost the economy in 2016.
“Record levels of consumer liquidity funded by income versus debt, alongside energy savings and the improved buying power of the dollar, have supported consumer fundamentals,” said Zentner.
Morgan Stanley Research noted that consumer balance sheets appear to be in good shape, and 80 percent of U.S. household debt is locked in at fixed rates.
Morgan Stanley forecasts 1.8 percent U.S. GDP growth in 2016 versus the consensus of 2.5 percent with a strengthening dollar and the hangover of weak energy prices likely holding back earnings-per-share growth.
The Week Ahead
Corporate earnings season is about to arrive this week with Alcoa kicking off earnings season on Monday after the closing bell. Briefing.com estimates 0.04 with Alcoa’s EPS.
J.P. Morgan & Chase will lead the financial sector on Thursday with their corporate results. Consumer spending will come into focus on Friday when December’s retail sales figures will be reported.
Economists from briefing.com forecast a 0.2 percent retail sales increase in December which would match the same level in November.
A warmer than expected December across much of the east coast has resulted in many U.S. retail stores not selling winter merchandise and could impact December retail sales figures.
It also remains to be seen whether Americans spent their savings in the economy after benefiting from lower gas prices in December when gas prices dropped to an average around $ 2.00 a gallon nationally.
Corporate earnings from the 4th quarter of 2015 will likely dominate the week ahead. The majority of economic reports next week won’t be released until Friday.
According to John Butters, V.P. and Sr. Earnings Analyst from Fact Set, fourth quarter earnings for the S&P 500 is estimated to decline -5.3 percent which is lower than the -0.6 decline that was estimated on September 30th at the start of the quarter.
Fact Set reports that for the quarter, 83 companies have issued negative EPS guidance and 28 companies have issued positive EPS guidance.
The 12 month forward P/E ratio is 15.7. This P/E ratio is based on Wednesday’s closing price (1990.26) and forward 12 month EPS estimate ($127.11).
Unsurprisingly, the Energy and Materials sectors are expected to report that largest year over year decreases in sales of all ten sectors for the quarter pushed lower by the plunge in crude oil and commodities.
The Energy sector is forecasted to report the largest year over year decline in earnings (-67.7 percent) of all ten sectors.
The Materials sector has recorded the largest decrease in estimated earnings growth (-25.9 percent) compared to (-6.1 percent) at the beginning of the 4th quarter on September 30.
Metals and mining lead the race to the bottom (-85 percent).
Telecom Service sector is the only sector that has recorded an increase in expected earnings growth with a 27.1 percent growth rate.
AT&T is predicted to be the largest contributor to earnings growth.
The Financial sector is estimated to report the second highest earnings growth of all 10 sectors with Citigroup projected to be the largest contributor to earnings growth for the sector with a mean EPS estimate of 1.08 versus 0.06 a year ago in the same quarter, according to Fact Set.
Full Economic Calendar
Tuesday- JOLTS job opening (November)
Wednesday- FED’S Beige Book (Jan.), Treasury Budget (Dec.), MBA Mortgage index, MBA Mortgage Purchase Index, Crude Inventories (1/09)
Thursday- Weekly initial and continuing jobless claims, Export/Import Prices (December), Natural Gas Inventories
Friday-Retail Sales (December), PPI and Core PPI (December), Empire Manufacturing (January), Industrial Production (December), Capacity Utilization (December), Michigan Sentiment (January), Business Inventories (November)