wmeubank@ocp.kcmo.com
PRUDENTIAL SECURITIES, INC.
One New York Plaza,
New York, New York
(June 9, 1997) STOCK INDEXES: Last week has to be one of the most classic examples of the stock market climbing the proverbial "wall of worry," as literally every measure of the market ended the week in all-time high territory. After worrying all week about negative pre-announcements for second-quarter earnings and Friday's jobs report, the market became "exuberant" following the non-farm payrolls figure, with the Dow making its sixth-largest gain (130 points) to close at a record 7435.
Last week was relatively light for economic releases, as is typical for the first week of every month when the jobs figures take center stage. The reports that were released prior to Friday continued to confirm that the economy is moving ahead, but not at the breakneck pace of the first quarter.
--Personal income and consumption for April were both up 0.1%, with
the latter being the lowest increase since last September. --The National
Association of Purchasing Manager's Survey for May rose to 57.1, up from
54.2 in April, to the highest reading since November 1994.
--Construction spending for April fell 0.1%, which was the first decline
in four months.
--The April Index of Leading Economic Indicators fell 0.1%, the first decline
in 15 months.
--The Johnson-Redbook survey of weekly chain store sales rose 0.5%. --April
factory orders rose 1.2%.
--Weekly jobless claims rose an unexpectedly large 19,000 to
337,000.
--The nonfarm payroll report for May showed an increase of 138,000 jobs,
significantly below the expectation of a 229,000 increase. However, April's
payrolls were revised upward to 323,000 from 142,000; the Much number also
was revised upward to 182,000 from 139,000. In addition, the May unemployment
rate unexpectedly fell to 4.8% from 4.9% versus the consensus expectation
of an increase to 5%; the latest unemployment figure is the lowest since
October 1973. Hourly average earnings rose by four cents after a one-cent
decline last month. The average workweek fell slightly.
On the surface, these non-farm payroll numbers could have been interpreted bearishly as the March and April job increases more than offset the lower-than-expected May increase. In addition, there should have been real concern when the jobless rate fell to an almost 24-year low, given the hand-wringing that occurred over last month's report that indicated labor tightness. Instead, the bond market made an astounding turnaround from an initial half- point sell-off to end the day higher by more than one full point, a move that pushed the yield down to 6.78%, its lowest level since late February. Apparently, the worrying was more than offset by the realization that increased productivity has resulted in a decline in unit labor costs, which probably is the primary reason inflation has remained low. In addition, the bulls also were helped by Treasury Secretary Robert Rubin, who said that chances are "high" that inflation will remain low.
As we have been pointing out for several weeks, the internal condition of the stock market has been extremely strong. In May, there was a changing of the guard as interest shifted away from the blue-chip giants to the secondary issues, which had lagged their more largely capitalized brethren. This imbalance was corrected to a great extent last month, as the Russell 2000 Index of small-cap stocks rose 11% versus a gain of "only" 4.5% by the Dow. This trend away from Dow stocks continued early last week as the Dow hesitated for the first four trading days, supposedly because blue-chip valuations were "stretched." However, the breadth numbers were positive every day except one. Significantly, the Value Line Index, which is a broad measure of 1,700 stocks, made new highs each of these days and demonstrated that the market was extremely strong internally. In light of last week's early action, it was the height of bullish irony that the Dow once again took center stage on Friday's explosion to new all-time highs.
Last week's breakout to new all-time highs, accompanied by new lows for the move in bond yields, could very well signal the start of a new leg higher in the stock market; setbacks should be well- contained. We also note that this move to best-ever levels has been accompanied by record short-selling as well, which could potentially fuel further upside fires. Due to the ongoing bullish configurations, we recommended a new bull put spread with the S&P options last week: buying the July 630 puts and selling the August 670 puts at a 35-point credit. This position is in addition to our previously established spread between long June 575 puts and short 670 puts at a 35-point credit. If the market can sustain itself at current or higher levels, we will recommend other combinations as well.
Don Selkin
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