A sharp increase in job losses shocked investors who were counting on a whisper number much better than analysts expected. Those hoping for an improvement to a loss of only 225,000 jobs were surprised by a much larger loss of 467,000 jobs in June.
The Non-Farm Payrolls for June took a severely negative turn lower with a loss of 467,000 jobs. The consensus estimates were for -355,000 jobs and there were whisper numbers as low as -225,000 jobs. The accelerating losses suggest the recession may not be over as many hoped. Goods producing industries lost -223,000 jobs while service-producing industries lost -192,000 jobs. Even government payrolls fell by -52,000 jobs. The separate Household Employment report showed self employed jobs fell by 374,000 in June. Average hours worked declined by -0.3% and weekly wages paid for those hours declined.
The unemployment rate rose to 9.5% and a 26-year high and analysts believe it will get worse before it gets better. Most analysts including the White House believe the unemployment rate will rise over 10% by early 2010. Remember, the unemployment rate is calculated only from those who are still on the unemployment rolls and receiving unemployment checks. The real unemployment, which includes those who have exhausted their unemployment benefits and have fallen off the rolls now exceeds 16.5%. This counts workers who are unemployed and looking for work, those who have given up looking for work and those underemployed. Underemployed means those who have taken temporary jobs to keep food on the table while they continue to look for work in their field. The number of unemployed workers who have been out of work longer than six months is now 29%, up from 27% in May.
Given the number of workers currently unemployed it will take years to produce enough jobs to put them all back to work. That number is something around 22.6 million workers if you include all classes. Actually Bill Gross puts this number somewhere around 35 million workers. Obviously quite a few are simply slackers that will never be gainfully employed on a routine basis but 15 million or so want to go back to work. It will take a long time for that to happen at the pre recession job creation rate of adding 250,000 jobs per month. Even if we had a strong rebound and created 500,000 jobs per month for a year that is only six million new jobs. We will never get to zero unemployment and something in the 4.5% range is normally seen as an ideal target. To reach that level about 12 million workers would have to find permanent work. The U.S. is a consumer driven economy. Obviously it could be several years before that happens and that means those 10 million workers are going to be spending a lot less and the economy is not going to be growing very fast.
Non-Farm Payrolls Chart
The only other report of note on Friday was the Factory Orders for May. Orders rose +1.2% and well over the consensus for +0.8 and the prior month at +0.7%. This gain along with the gains in the regional manufacturing reports and the national ISM last week suggest the economy is rebounding. However, the job loss numbers suggest the rebound will be slow and painful. The June national ISM on Wednesday rose to 44.8 from 42.8 and the sixth month of gains but it is still in contraction territory.
National ISM Chart
The Factory orders chart for the last year paints an encouraging picture of the rebound in the economy. However, when viewed against the larger 15-year timeframe the amount of recovery is barely visible. The larger chart shows the magnitude of orders lost and just how hard it is going to be to return to the level of productivity and consumption we experienced several years ago. We have already more than doubled the drop in orders we saw in the 2001 recession.
Economy.com Factory Orders Chart - 12 months
Economy.com Factory Orders Chart - 15 years
For the coming week there is very little on the schedule. The ISM Services on Monday will be of interest but the numbers are usually ignored. I added the note auctions to the calendar because these are going to be the eventual straw that breaks the markets back. I have been warning for three months that odds were increasing for an auction failure. The government is trying to sell $2 trillion in debt and eventually it will run out of buyers. That is not expected to happen this week but we need to keep an eye on the 10-30 year auctions for sings of decreasing demand. $73 billion in notes will be offered. They will also sell $63 billion in 3-6 month bills.
The Treasury is selling the 10-30 year notes next week under what is called a "reopening" of a prior series. Basically if the original series was sold in January 2009 with a due date of January 2019 for a ten-year note then a reopening of that series today produces a 9.5-year note with a 10-year label. That shorter duration note produces a slightly higher yield for investors and is an added incentive to bid. Eventually the Treasury will run out of games to play to entice buyers and the auctions will fail. That will be an extremely serious event for the equity market.
However, in a strange twist of fate the sharp increase in job losses will actually produce more bidders this week on fears that the recession will linger. The auction will provide a safe haven for those who fear a double dip recession or a recession that does not recover until 2010. If the government could continue producing negative economic data they would have no trouble selling the debt. Conspiracy theorists beware.
Crude prices imploded on the higher than expected job losses. Crude prices fell -2.58 to close at $66.70. This is a major reversal from the $73.38 high on Monday. There are so many cross currents in the energy sector today that predicting the price of oil is best left to chimps with darts. On Wednesday we saw crude inventories fall by another 3.7 million barrels. This should have been good for a monster spike when reported in conjunction with more outages in Nigeria and rising tensions between Russia and Georgia. Instead there was an opening spike and sharp sell off that continued into Thursday.
Since the May 1st high for oil inventories at 375.3 million barrels we have seen a sharp decline in all but one week to 350.2 million barrels this week. On the surface that is bullish but the demand numbers are killing the price. Refinery production is higher than the demand rate for distillates. That demand for distillates including diesel is at the lowest level in over six years. While oil inventories are plunging the distillate inventories have risen ten of the last eleven weeks and are currently 28.4% over last years July 4th levels.
To put these facts in perspective summer gasoline demand appears to have peaked, which is normal just before the July 4th holiday. Diesel demand is falling and that suggests lower shipment volume for goods shipped either by truck or by train. Lower goods shipments means lower consumption and signs that the recession may not be over. We heard from the railroads a couple weeks ago that shipments had picked up slightly but there has been no follow through on those reports.
Add in the sharp drop in employment and it suggests that demand will continue to slow. This means that oil prices are going to be more volatile until signs reappear of demand increases. One analyst was asked if he thought oil prices would hit $55 or $85 before year end and he said "yes" that he expected both to be hit. If we get any additional signals that the economy is not improving as expected then oil prices are likely to continue lower.
However, Baker Hughes reported another 11 rigs in the USA were put back into service last week. That is the third consecutive week for gains totaling 52 rigs put back to work. Considering the active rig count had fallen from 1,921 this time last year to 876 three weeks ago those 52 rigs are a drop in the bucket but at least a sign that activity is picking up and the decline may have bottomed. Unfortunately most of those rigs will probably be drilling for natural gas and gas prices have fallen about 21% over the last three weeks. Gas was trading for as much as $4.57 on June 16th and closed Friday at $3.61. That increase in the rig count was probably stimulated by the rise in gas prices from the $3.52 low back in May and now the price of gas has returned to those lows in a very short time. However, we know that the major producers are currently constrained and are producing well below their maximum capacity in order to maintain prices. With another 600,000+ workers filing for unemployment every week they may need to close those valves a little tighter to keep prices in range.
Only a year ago this month crude prices hit $147 per barrel. Unemployment was 5.6%. Over the last July 4th holiday U.S. gasoline prices were well over $4 per barrel. I remember paying $4.93 per gallon in California in late June. Consumers should celebrate these low prices this July 4th because they are not likely to return in our lifetime once the recession ends and the demand cycle returns. The IEA said last week that global demand was expected to exceed 89 mbpd by 2014 compared to 85.8 mbpd in 2008. This is a challenge since most geologists believe 87 mbpd is going to be the world's maximum production capacity. The IEA also said OPEC capacity will grow by 1.7 mbpd by 2014. That sounds reassuring except that that was a downgrade from their prior forecast for a gain of 3.2 mbpd. The lower outlook is based on reduced cash flow available for exploration and maintenance, geopolitical turmoil, increased resource nationalism and offsets for depletion.
When oil prices decline the OPEC producers have less money to spend on exploration and maintenance. They have huge bloated social budgets that are primarily funded by oil sales. When there are insufficient funds from sales the side that gets cut is exploration. Cutting social programs creates social unrest and monarchies and dictatorships will do anything to keep unrest low and remain in power. That usually means allowing production facilities to decline for lack of maintenance and infrastructure projects like pipelines and pumping stations are cancelled. With no way to get oil to market the amount of drilling declines pushing new production farther into the future. Meanwhile existing oil wells continue to deplete and production is slowing. This is all going to come back to bite consumers in the wallet once demand increases. Peak oil did not go away and will be back with an even greater ferocity very soon.
Natural Gas Chart
In stock news Oracle (Nasdaq:ORCL) told labor unions that it would layoff 850-1000 workers in Europe. These are the first job cuts for Oracle since the recession started. That is only 1% of its global staff of nearly 86,000 employees. Oracle recently reported earnings that showed revenue declined over the last quarter.
Airlines continue to decline with United (Nasdaq:UAUA) closing at $3.31 and very close to a 52-week low. The falling oil prices played havoc with their fuel hedges and cost nearly all the carriers tens of millions of dollars when they had to buy them back for a loss. Then passenger traffic died, especially the lucrative business traffic. Airlines continued to cut planes and routes in an effort to reduce capacity. Then fuel prices increased sharply again as passenger traffic fell even further. Additional charges for everything from baggage to peanuts and drinks temporarily filled in some of the revenue gaps. Now with two airlines considering charging for bathroom admission this shows you just how desperate the airlines are to raise money.
Delta (Nyse:DAL) is expected to post another year of substantially negative cash flow for 2009 according to a recent report. All the airlines are burning cash and stockpiles are dwindling. US Airways is down to $2.1 billion, American $3.3 billion, United $2.5 billion and Delta $5 billion. United sold $175 million in secured 3-year notes last week. The security was spare parts. That does not give you a good feeling about United's health if they had to borrow money on their parts inventory. The notes had a face rate of 12.75% but were sold at a discount that gave a 17% yield. The high yield is a representation of credit quality.
S&P analyst Phil Baggaley says the stocks are pricing in the potential of another round of bankruptcies. American (Nyse:AMR) and United are expected to lose $1 billion each in 2009 and that assumes oil prices remain flat. When the next oil price cycle pushes prices back over $75 these carriers are going to be bleeding cash at an even faster rate. Airlines are fighting things like swine flu that cost them a month of traffic losses before the headlines disappeared.
United Airlines Chart
The states are not doing much better. California began paying its bills this week with IOUs. California has a $26.3 billion budget deficit. The "checks" are green but they can't be cashed until October. More than 28,000 IOUs worth $54 million were printed last week. Most of them were to people expecting tax refunds. The checks are dated Oct-2nd but some banks are cashing them early. BAC, WFC and JPM Chase have announced they will cash them now for existing customers. The IOUs have a 3.75% interest rate and anyone cashing them now will lose the interest and the banks will benefit since they will hold the checks until Oct 2nd before tendering them to the state.
In the "you can't make this stuff up" category Senate Democrats unveiled a bill on Thursday that fines anyone who does not have health insurance more than $1,000 a year per person. A family of four would pay over $4,000. Democrats expect to raise $36 billion a year from this plan. The fines would be set at a minimum of one half the cost of basic medical coverage. Kaiser Insurance said in 2008 employer paid coverage for a family averaged $12,680 a year for a family of four and $4,704 for an individual. The fines would be collected through the IRS income tax system. Unbelievable.
Just as unbelievable was the sudden resignation of Alaska governor Sarah Palin on Friday. No reason was given and she is turning over the reigns to the Lt Governor on July 26th. Palin had been expected to run for President in 2012 but this poses even more questions for the media to pick apart. Far as I can tell there was no mysterious trip to Argentina in her recent past. This story will be all over the news for weeks as the press tries to find out why she is dumping her job half way through her first term.
While in the political surprise category Colin Powell, who was credited with the last minute blessing of the Obama candidacy and guaranteeing his win, turned against President Obama in an interview on Friday. Powell said the ambitious Obama initiatives would create too much government and increase the Federal debt to a point where it could not be paid. Let's see, six months ago Powell thought President Obama was an important transitional figure and now he believes the president has overstepped his mandate and is going to bankrupt the country. Sounds like politics as usual.
One more YCMTSU note. In Britain the rage now is to hold a "swine flu" party. The theory is to have a party where people who are well mingle with people who have swine flue in an effort to catch the flu. The reason given is to catch the flu while it is less lethal and build up immunity to it before it mutates into a more lethal form. The current version of the swine flu is a new strain never before seen and humans don't have any natural immunity to it like we have built up from centuries of other types of flu strains. The mortality on the current strain of swine flu is very low and thus the incentive by the Brits to catch it now. I may be laughing at them now but if this new and improved version comes around next year with a 50% mortality rate the Brits will have the last laugh.
The FDIC wanted to take Friday off as well so they closed seven more banks on Thursday bringing the total for the year to 52. That is more than twice the 25 closed in 2008 and 16 times the total of 3 closed in 2007. The FDIC said the cost to the fund for all seven banks would total $314 million. Five of the banks were in Illinois, one in Texas and one in Oregon. Illinois is having a hard week. It was also reported that the number of confirmed and suspected swine flu cases in Illinois rose this week by 291 to 3,166. Time for a party!
Starting next week earnings will set the tone for the markets. Dow component Alcoa (Nyse:AA) will kick off the earnings cycle when it reports on Wednesday. So far we have seen the markets rebound nearly 35% from the March lows on hopes for a rebound in earnings and the economy. Traders are going to be watching the Q2 earnings to see if their hopes were justified.
It will be interesting to see how investors react to companies that post "less bad" earnings rather than something that shows definite improvement. Earnings are supposed to come in at -35.5% below Q2-2008 according to S&P. All 10 major sectors are expected to show declines. The energy sector will be the worst simply because the comparisons are so bad. Oil was over $125 in Q2-2008 and it was $65 in Q2-2009. That projects earnings in the energy sector to fall by -78.9%.
In Q1 companies got by with claims of drastic cost cutting and restructuring charges to give themselves a more positive outlook. Now three months later investors will want to see proof those draconian moves paid off with some better earnings. On July 14th Goldman Sachs (Nyse:GS) will kick off the financial reporting cycle. The financials are widely expected to post better than expected earnings because of the end of the mark-to-market rule and because of their sales of some high-risk assets. The banks are also going to disclose if they paid off the TARP loans and escaped the government bailout TRAP. They will also disclose how much it cost them to buy back their warrants and the dividends they paid on the loans.
The markets tanked hard on Thursday but we should not apply too much weight to the event. The volume on Thursday was the lowest day of the quarter and the rest of the week was not any better. Stops were hit on the knee jerk reaction to the jobs data and unlike normal days there was nobody around to reload those positions and buy the dip.
Market Internals Table
The Dow collapsed back to support at 8300 after coming very close to 8600 on Wednesday's spike. The Dow was handicapped by big losses in IBM (Nyse:IBM), Chevron (Nyse:CVX), Exxon (Nyse:XOM), United Technology (Nyse:UTX)and Travelers (Nyse:TRV). Remember, it was an extremely low volume day and there simply were no traders to buy the dip.
The Dow clung to initial support at 8300 until the final minutes of trading. Odds are good that we will see strong support at 8250 tested next week. This is a critical level that really needs to hold or the bears will begin to pile on for a push down to about 7750.
The S&P-500 fell to just over psychological support at 900 and held there until the close when the sellers overwhelmed remaining buyers to push it down to close at 897. The S&P has strong support at 880 and I expect that to be tested. The head and shoulders pattern on the S&P is so clear I wonder if a lot of traders may try to fade it instead of load up the truck with shorts. The H&S is not perfect with the right shoulder slightly weaker but it should be close enough for most traders to wait on the sidelines to see if it breaks to the downside. As long as the S&P holds at 880 the bulls will likely retain their confidence. A break under 880 could get ugly very fast.
The Nasdaq lost only -41 points for the entire week despite the -49 point loss on Thursday. It has pulled back to the support of the 30-day average and the psychological 1800 level. There were only two stocks on the Nasdaq composite that gained over $1 on Thursday (PEET, MTXX) but there were quite a few that finished in positive territory. Many of them were chips. (LRCX, LLTC, NVLS, BRCM, ATML) The gains were not large but at least they were gains on a bad market day. This is overall positive for the Nasdaq when the chips can hold their gains. From Thursday's close at 1796 decent support is 1760 followed by 1675.
The broadest market index now called the Dow Total Stock Market Index (previously Wilshire 5000) fell back to 9200 with strong support at 9000. This index eliminates the stock weighting problems of the Dow. Unfortunately it suggests there is some pain ahead as it pulls back to strong support at 9000.
Total Market Index Chart
Last week I warned the path of least resistance was down and given the bad news I was not surprised by the decline. We need to realize that the third quarter really begins next week. Volume for the last couple days has been almost nonexistent and the real trading won't begin until next week.
The problems to overcome will be the bond auctions and worries about weak bidding. While the market may worry about it I don't think it will be a problem once the smoke clears. The next biggest problem will be the start of earnings and a few lingering earnings warnings. There are bound to be a few who waited until the last minute to warn. I actually expected a couple to appear after the close on Thursday to try and sneak in when nobody was watching. It did not happen so maybe the worst warnings are behind us.
One analyst said on Friday the problem for the market over the next couple weeks was going to be the "gap trade." I immediately started looking at the charts for the unfilled gap but that is not what he was talking about. He said it was the gap between the reality of earnings and the expectations of traders. I thought that was a perfect explanation of how the earnings cycle will be interpreted. Traders are all "hoped up" with nowhere to go if those expectations are not met.
Also weighing on traders is the arrival of Death Valley days for tech stocks. I mentioned this on Tuesday that July begins the worst four months for tech stocks in a normal year. We have yet to see whether DVD will appear in 2009 after the crushing first quarter. I still believe the path of least resistance is down and the indexes closed either right on or just above strong support so either direction is possible next week. We have not seen any influx of retirement money yet so there is still the potential for a short-term blip.