Blog : Penny Stock Week: Why Stocks Are Soaring

by Ed Zwirn on June 9th, 2014

The recent performance of the stock market has left many scratching their heads. With major large-cap market indices like the S&P 500 and the Dow Jones Industrial Average at or near all-time highs, and smaller-cap stocks catching up, it is tempting to second-guess these results and wonder whether we are in the midst of another equity bubble.

But there are solid reasons propelling the recent gains seen by many stock market investors. For one thing, the U.S. economy, once you get past this year's disastrous first quarter, has actually seen some solid gains, with everything from the labor market to factory and construction orders and motor vehicles putting in stellar performances, at least since the spring thaw.

Perhaps more significant when it comes to assessing the stock market's performance are the policies of the world's central banks. The U.S. Federal Reserve and the Bank of Japan have been on an expansionist mode for some time now. They are now being joined in this in a big way by the European Central Bank, which last week officially abandoned whatever residual inflationary fear it may have possessed to announce negative interest rates in an attempt to boost inflation and stalled economic growth.

It remains to be seen whether this latest accommodative policy announcement will succeed in helping Europe out of its plight, but there is no doubt that investors are already taking their cue. 

Last week saw the S&P 500 hit another record and the Dow Jones Industrial Average close Friday at 16,924.28, up 1.4% from the 16,717.17 noted last on the Peter Leeds site.

At the same time, the broader market, particularly penny stocks, outperformed, with the NASDAQ composite gaining 1.9% on the week, following up on a 1.4% gain. Penny stocks, as measured by the Russell 2000 small-cap index, gained 2.7% on the week, following the 0.7% rise seen the week before that.

These gains were supported by a set of basically benign economic releases: 

-- Monday morning brought word of a slowdown in the rise for construction spending. April came in with a lower-than-expected 0.2% rise, following March's upwardly revised 0.6% increase.

-- Tuesday's factory orders report also provided evidence of a continued upswing, rising 0.7% following March's upwardly revised 1.5% spike.

-- Tuesday also brought good news from the motor vehicle sector. Sales of autos came in at a rate of 5.7 million in May, up from April's 5.3 million, while trucks sold at the rate of 7.7 million, up from 7.5 million.

-- As widely noted, Friday's employment report showed the economy crossing a dubious threshold. As of May, the U.S. economy has finally made up for the job losses incurred by since the start of the most recent recession more than six years ago. Nonfarm payroll employment fell by 8.7 million from January 2008 through February 2010. Since then, employment has risen by 8.8 million through May.

Taking a shorter-term view, the report showed that job creation in the U.S. reverted back to recent trend following April's blockbuster news of the creation of 288,000 jobs and an unemployment rate downtick, from 6.7% to 6.3%. Job creation for May, it was learned, came to 217,000, close to the consensus, lower than the 234,000 average attained over the past three months but higher than the 197,000 average number of jobs created during the 12 months prior to that.

In addition, in a slight surprise to investors, the unemployment rate held steady during May, at 6.3%, as the number of discouraged workers remained high and the labor participation rate held steady at 62.8%. Hourly earnings as expected rose 0.2% after staying flat in April, and the average workweek remained unchanged at 34.5 hours.

Looking ahead this week:

-- Thursday morning's retail sales report is expected to show a 0.7% May increase, following April's 0.1% rise. Excluding the auto sector, the rise for this indicator is expected to come to 0.4% following April's flat reading.

-- Look for Friday's producer price index update to show a 0.2% rise for May, following April's 0.6% increase. The "core" figure, which excludes food and energy, is expected to go up 0.1% following April's 0.5% increase.

Looking a bit farther ahead:

Although the June 18 Fed monetary policy statement is expected to hold center stage for investors next week, there seems to be little room for maneuver on the part of the U.S. central bank governors following the recent ECB decision to effectively devalue the euro. It almost goes without saying that the Fed will announce a further $10 billion "tapering" of its monthly quantitative easing purchases of Treasury debt and mortgage-backed securities this time around. But both the weaknesses in the current strong jobs numbers and the ECB action effectively take any further tightening off the table, with any talk of higher interest rates unthinkable as Europe lowers rates below zero.