The forward earnings per share (EPS) for all S&P 500 companies combined increased last week from $159.02 to $167.58. The sizable increase in EPS is attributed to the rollover into a new quarter/year. (Note: the decline in EPS for the prior two weeks was a result of adding Tesla to the S&P 500 index. Tesla has very low-profit margins while they invest heavily to increase production. The inclusion of the company – which is now the 4th largest company in the S&P 500 – brings down the EPS projections for the entire index.)

The S&P 500 index increased by 1.83% last week, but the increase in the EPS was larger than the increase in price. Therefore the price to earnings (PE) ratio actually declined from 23.6 to 22.8.

Treasury bond rates broke above 1% for the first time since March.

If we zoom out to a 10-year chart we can see the prior swing lows in 2012, 2016, and 2019 (in the range of 1.336% to 1.429%) appear to be the logical upside target.

The increase in EPS corresponded with an increase in the earnings yield on the S&P 500, from 4.23% to 4.38%. The yield on the 10-year Treasury bond increased by a greater amount (0.917% to 1.105%), thereby the equity risk premium declined from 3.317% to 3.277%.

Q4 earnings will begin on Friday as the big banks start reporting. 18 companies have already reported results, and all 18 have beat expectations by a combined rate of 13.1%. So we are off to a good start.

Weekly review of economic data

ISM Manufacturing PMI reported its seventh straight month of expansion. 60.7 is the highest monthly reading since September 2018 and one of the highest readings in the last decade. The gains were broad-based, with “4 of 5 sub-indexes in strong growth territory.” A solid report all around, that surpassed even the most bullish estimates.

The ISM Services PMI came in at 57.2 for December, which beat estimates and the prior month's reading of 55.9. With 7 of the 11 sub-indexes reporting trend direction of growing or increasing.

“The past relationship between the Services PMI™ and the overall economy indicates that the Services PMI™ for December (57.2 percent) corresponds to a 2.9-percent increase in real gross domestic product (GDP) on an annualized basis.” per the Institute of Supply Management

My weighted ISM (which takes into account the approximate size of the Manufacturing and Services sectors in today's economy) increased from 56.3 to 58.1. Any reading above 50 is expansionary, and a reading of 58.1 is the highest single month reading in 2 years.

The monthly employment report was disappointing. The street was expecting an approximate net gain of 60,000 jobs, while the result was a net loss of -140,000, attributed to a steep decline in the leisure and hospitality sector (bars & hotels). Last month's number was revised up from 245,000 to a net gain of 336,000. The unemployment rate remains at 6.7%.

While much of the economic data supports the continued expansion, this report was a sobering reminder there is much work to be done to get back to full employment. The cumulative jobs recovery chart above shows the economy lost a net 21.57 million jobs to COVID, and 8 months into the recovery we are still a net 9.377 million jobs below the pre-COVID high point. In percentage terms, we have only recovered about 56% of the job losses from March and April. Historically, jobs recoveries take many years. I’m much more optimistic about this recovery because the dynamics are quite different from typical recessions.

On the positive side, average hourly earnings increased by 0.8%, which is the highest single month reading since May. The latest estimates for Q4 GDP are 8.5%. If that number is realized, that would mean the economy would have recovered about 94% of the COVID losses. In legal terms, the preponderance of evidence still shows the economic expansion is alive and well.

Summary: Financial conditions continue to improve (as the yield curve continues to steepen while the dollar declines), uncertainties are being removed, and the economic and earnings recovery is mainly intact. Interest rates are rising in anticipation of stronger economic growth and/or inflation, but are still nowhere near high enough to threaten stock valuations (in my opinion at least). The market has clearly been wrestling with the near term slowdown, in contrast to better expectations in the not to distant future. Stocks are overlooking any signs of a near term slowdown right now. We are starting to see signs of optimism amongst market participants. Ironically, I prefer investing when everyone is fearful.

This week we have some key economic data points such as small business optimism, Inflation (CPI), and retail sales. And Q4 earnings will kick off later in the week as the big banks begin reporting.