The Dow and S&P hit two month lows on Thursday with the Dow down -100 at the lows after economic reports continued to paint a grim picture of the U.S. economy.

Market Statistics

Following yesterday's very negative ISM and ADP numbers the Factory Orders report today was just icing on the economic cake. Factory Orders declined -1.2% in April compared to a +3.8% gain in March. Durable goods orders declined -3.6% compared to a +4.6% gain in March. This was not good news because this is a lagging report for April and is now expected to show a substantial decline when May numbers are reported.

Chain Store Sales for May rose +5.4% but that was also well below the +8.5% in April. However, the headline number was inflated by a +1.7% rise in gasoline sales. Higher prices for gasoline equals higher sales. That means the real retail sales for May were actually more in the +3.7% range and less than half of April's rate. Higher gasoline prices did impact retail sales simply because that reduces the amount of money consumers have to spend on other things.

New Jobless Claims were basically flat at 422,000 compared to 428,000 in the prior week. With claims holding stubbornly above 400,000 it suggests the job market is not improving and could be on the verge of a new decline. However, only four states reported an increase in claims by more than 1,000. Those were California, Massachusetts, South Carolina and Wisconsin. We are still seeing impacts from the break in the supply chain from Japan and that is the major qualifier to any story on jobs.

Weekly Jobless Claims Chart

The Japan qualification is important when talking about expectations for Friday's Non-Farm Payrolls report. In April there were 244,000 jobs created and consensus expectations were for a gain of +185,000 for May. However, after the ADP report disappointed on Wednesday those estimates took a serious plunge. The table below shows all the revisions I could find. The average estimate declined by 57,250 jobs to average 117,000. However, I would be VERY surprised if it is not well under 100,000.

Jobs Estimate Revisions

The ADP report was expected to show a gain of 180,000 jobs but the number came in with only a gain of +38,000. That is a significant drop. The ADP survey is based on 24 million employees at firms where ADP processes their payroll. The BLS survey on Friday theoretically covers all 140 million U.S. workers. The two surveys frequently come up with different answers but the ADP number is still seen as a proxy for the NonFarm report.

The National Federation of Independent Business (NFIB) said a survey of 733 small businesses found the average number of net new jobs per company slipped to 0.01 per company in May. That is about as low as you can go without slipping into job losses. The number was 0.04 in April. According to this monthly NFIB survey there has been effectively ZERO job growth in the last two months. Companies in the south central states and New England reported a decrease in jobs.

The other report out on Friday is the ISM Nonmanufacturing Index commonly referred to as the ISM Services. The index was expected to improve to 54.0 after posting a 52.8 reading for April and a cycle high of $59.7 in February. However, the sharp decline in the ISM Manufacturing report on Thursday suggests the services version could actually go negative. That would be very bad for the market since the U.S. economy is now more services based than manufacturing based.

ISM Services Chart

The ISM Manufacturing report on Wednesday declined from 60.4 to 53.5 and very close to contraction territory. That stretches its decline over the last three months to -7.9 points. New orders and back orders both declined more than 10 points to just over 51.0. This was an ugly report that suggests rougher times ahead. This large of a drop in the ISM would indicate the estimates for GDP growth in Q2 are way too high and growth could be under +1.0%. Obviously the breakdown in the Japan supply chain is a major factor for the May report but that does not show up in the headlines. You have to have a grasp of global economics and the amount of components we receive from Japan for thousands of products to understand the impact to our manufacturing process. 99% of investors see the headline number and run for the exits. It may not be that bad but we won't know until next month.

ISM Manufacturing Chart

Crude oil prices declined -$2 to $98.50 intraday after the EIA inventory report showed an unexpected gain in oil inventories of +2.9 million barrels plus a rise of +2.6 million barrels of gasoline. Analysts were expecting a small decline as supplies move into the retail channel to accommodate the holiday weekend driving. Apparently the demand was lighter than expected although the EIA said gasoline demand rose to 9.431 million barrels for the week ended on May 27th. The demand for the prior week was 9.025 million barrels.

Inventory Snapshot

The increase in crude inventory to 373.8 million barrels pushed inventories to the highest level since April 2009 at 374.6 million. You have to go back to July of 1990 for a higher inventory number with the all time high of 391.9 million. There is NO shortage of oil in the USA. This should push gasoline prices lower. The blue area in the chart below is the 5-year average.

U.S. Oil Inventory

Historical Crude Oil Inventories

U.S. crude oil continues to hold over $100 because of the strength in Brent. Lower shipments out of the North Sea and the halt in Libyan production is putting a premium on Brent light crude supplies. As long as Brent remains supported the price of WTI will remain in the $100 range despite the near record inventory levels.

WTI Crude Chart

Brent Crude Chart

The dollar declined to a new four-week low intraday due to the negative economic numbers. This helped produce a rebound in commodities and pushed oil prices back into positive territory. Equities also rebounded when the dollar began to fall. Strange but true. Bad economics pushed the dollar lower but the falling dollar supported equities.

Dollar Index Chart

Helping to prompt the afternoon rebound was news that Greece was set to impose a deeper bout of austerity and speed up a privatization drive in return for a new international bailout in order to avoid a debt default. Greek Prim minister George Papandreou will present the plan to the euro zone finance ministers on Friday. Senior officials, meeting in Vienna have agreed in principle toa new three-year program to run until mid-2014. That would supersede the $159 billion rescue agreed to by Greece, the IMF and EU just a year ago. Greece owes 340 billion euros in debt and that is increasing each year due to continued budget deficits. Moody's cut their rating again this week to Caa1 and the same level as Cuba. Only one country has a lower rating and that is Ecuador, which defaulted on $3.2 billion in debt in 2009.

Also weighing on the markets was another warning from Moody's that a U.S. failure to resolve the debt ceiling soon would risk a debt downgrade. Moody's said the U.S. had only "weeks" to resolve the problem and warned a quick solution was vital. Moody's warned there is now "a very small but rising risk of a short-lived default" given the political impasse over how to resolve the U.S. financial problems. Republicans and quite a few democrats are now demanding significant spending cuts be tied to an increase of the debt ceiling over the current limit of $14.29 trillion. Like Greece we can't continue to run budget deficits in the trillions that have to be financed by selling even more debt. Lawmakers are expected to reach a compromise for a new ceiling in the $16 trillion range but that only succeeds in kicking the can down the road for another year before the subject will again surface after the 2012 elections.

Stock news was minimal today with 99% of the chatter covering economics, U.S. debt, jobs and the European debt crisis. We did learn that Groupon filed for a $750 million IPO to take advantage of the current IPO hysteria. The IPO will be made up of new shares and shares currently held by insiders but we don't know the quantities of each. Groupon raised $950 million in January from some private investors so there will still be some deep pockets holding stock after this IPO.

Of note in the filing Groupon said its revenue in Q1 was $644 million compared to revenue for all of 2010 of $713 million. However, the company reported a net loss of -$456 million in 2010 and -$147 million in Q1-2011. Groupon spent $179.9 million in the first quarter just getting new subscribers, which now total 83.1 million. They are operating in 175 North American markets and 43 countries. They currently have 7,100 employees and are hiring.

Groupon said in the filing they expect to increase operating expenses substantially in the foreseeable future as we continue to invest in increasing our subscriber base and the number and variety of deals we offer daily. There are more than 45 competitors to Groupon with Living Social, backed by Amazon, as the one most would recognize.

Underwriters will be Goldman Sachs and Morgan Stanley with no timeframe for the IPO. The symbol will be GRPN.

Goldman Sachs was also in the news for another reason. Goldman was subpoenaed by the Manhattan District Attorney's office for information on the firms activities ahead of the credit crisis. This subpoena is related to the Senate's investigations into Wall Street's role in failure of mortgage-backed investments. Michigan Senate Democrat Carl Levin released a 640-page report in April where Goldman was used as a case study for the cause of the credit crisis. The Department of Justice and the SEC are also investigating Goldman on the basis of that report. Shares have declined -16% since the report was released in April.

Goldman Chart

The market has returned to its downtrend despite the short covering rally on Tuesday. The S&P and Dow touched new two month lows and the outlook continues to be for more of the same. Historically June is the third worst performing month of the year for the S&P since 1957. The decline in not much at an average of less than one percent but it is persistent. The first week of June is normally the strongest with the last three weeks erasing any early month gains. September is the worst month with February in the number two spot.

This is the "why buy" season as the summer doldrums overtake the markets and volume declines sharply. However, volume this week has been very good. Tuesday's short squeeze traded 8.2 billion shares but was followed by 8.1 billion on Wednesday's decline. Today was only 7.1 billion because I suspect everyone already has their positions set while they wait for the nonfarm payroll report on Friday. That should be a market mover either because it will be worse than expected, which would be dramatic, or possible better than the horrible expectations changes I listed above. After Friday the summer volume drop will arrive and the indexes will be to smolder like a dud 4th of July firework. There will still be smoke but we will never know when it will die out completely or suddenly explode.

The S&P has broken below key support of the 100-day average and is very close to retesting 1300 or even 1295. If the payroll report is worse than expected I believe we will see the S&P setting up for a break of that support at 1295 and a retest of 1260 before summer is over. We have almost an entire month ahead of us before the next round of regional economics so investors will be left to chew on the hard facts from the last set that show the economy slowing dramatically.

S&P Chart

The Dow tested support at 12,200 this morning before rebounding to close on the 100-day at 12,244. The 12,200 level is going to be a crucial support test. A break there could target 11,600 very quickly if economic conditions continue to disappoint.

Dow Chart

The Nasdaq is neutral and closed with a slight gain today. It is well above critical support and not showing the same weakness as the Dow and S&P. It was helped by BIDU +6, SINA +6, PCLN +6 and NFLX +5. Apple and Google cooperated by closing in positive territory but with no major gains. It was enough for them to not be a major drag on the index.

Support on the Nasdaq is 2760 and 2750. Wednesday's -66 point decline pushed it into oversold so today's nearly breakeven performance was probably more of a pressure equalization than some statement on the health of techs in general.

The Russell also finished flat after a monster decline on Wednesday. No conclusion can be derived from the Russell chart today.

Nasdaq Chart

Russell Chart

In summary Friday will be all about the payroll report. The markets have priced in some severely negative expectations so anything that is not a substantial downgrade may be met with some short covering ahead of the weekend. Likewise if the number comes in much under 100,000 new jobs we could also see some further discounting of our future economic growth.

Lawmakers can't help because stimulus and spending are now four letter words. The Fed's monster $2.7 trillion stimulus program or QE1 and QE2 has apparently been a failure but they are the only force in the market that can pull another rabbit out of their hat in an attempt to rescue the sinking economy. The Fed has a very negative public image today so anything they do could be seen as a hail Mary pass. Several analysts have said a QE3 program could now produce a bear market because it will be seen as an act of desperation.

The jobs report is going to be a key indicator of the current economy. Keep your fingers crossed but expect and prepare for the worst.

Definitely, enter passively and exit aggressively.

Jim Brown

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