Stocks rallied in late trading on Friday, concluding a relatively flat week for the indexes. The S&P 500 gained 0.19 percent, while the Dow Jones Industrial Average was up 0.03 percent for the day. For the week, the S&P 500 and DJIA lost 0.1 and 0.6 percent, respectively. The Nasdaq continued to move higher however, gaining 0.4 percent on the day and 0.7 percent for the week. With only one trading day left in June, each of the indexes is positioned to finish higher for the month.
We now understand why Janet Yellen wasn’t disturbed by the jump in the inflation data last week. The CPI for May came in at 0.3 percent, indicating inflation could be heading above the Fed’s target range. However, the core PCE (personal consumption expenditures) for May was 0.2 percent. Since this is the gauge the Fed uses to implement policy decisions, it tells us the Fed will remain dovish for the time being. The trend in inflation remains upward, but until the core PCE starts moving higher, the Fed will not change its current policy orientation.
Additionally, the PCE report showed consumer spending was up only 0.2 percent, in line with inflation. This is quite disappointing and may cause some economists to start cutting their second quarter GDP growth forecasts. Growth rates should still be solid, but may not reach the 4 percent level many had predicted.
Combined with the first quarter GDP final estimate reported on Wednesday, it’s easy to see why the Federal Reserve isn’t worried about inflation. Government economists estimated the economy contracted at a 2.9 percent annualized rate in the first quarter. If the economy grows at 3 percent for the rest of the year, GDP growth for 2014 will be 1.5 percent, at the low end of the post-2008 range.
The weak data rattled stock market investors, but equities stayed near their highs. Technology stocks continued to recover from the spring sell-off as the Nasdaq Composite reached a new 52-week high on Wednesday. Volatile sub-sectors such as biotechnology and internet shares were also steady. If the prospect of slower growth continues, investors will likely gravitate towards more aggressive sectors in search of higher returns.
Slower growth will also favor high quality dividend paying companies. If interest rates remain low, it will keep dividend shares attractive relative to fixed income. Dividends may also make up a larger portion of stock returns as a result of weaker growth numbers.
It is not time to concede a slower growth trend just yet. This week we also saw the flash PMI for June, which climbed to a reading of 57.5. Anything above 50 indicates expansion in the manufacturing sector. Rail data also continues to show a pickup in the economy. Manufacturing leads the economy and this pickup signals stronger growth over the coming months. In contrast, consumer spending is a lagging indicator. The U.S. economy has a large consumer sector, but consumption is the last stage of the economic cycle. When manufacturing, raw material and energy production is improving, it is a very good sign. We will just have to wait to see if the growth rate will be as strong as once predicted.