The economic virus appears to be spreading with disappointing numbers on jobs and services pushing the Dow and S&P to the first five-week losing streak since July 2004.
It was a bad week for the markets with a -2.3% decline in the major indexes due almost exclusively to the economic news and very disappointing numbers. News of a compromise on Greece was actually a positive for the market on Friday that prevented an even further decline. The drop in the Dow was the biggest weekly decline since August.
The big news on Friday was of course the worse than expected Non-Farm Payroll report. The headline number dropped to a gain of only 54,000 jobs compared to the +244,000 headline number for April. That 244,000 number was also revised lower to 232,000 and March was revised lower from 221,000 to 194,000. The downward revisions totaled a drop of 39,000 jobs.
Initial jobs expectations were for a gain of +185,000 and that was revised down on Wednesday after the disappointing ADP numbers to +117,000. The actual number turned out to be less than half of the lowered expectations. The unemployment rate rose to 9.1% and the second consecutive monthly increase since its low for this cycle at 8.8% in March. The broader measure of unemployment referred to as U6 that takes into account everyone unemployed, on and off of unemployment benefits and those forced to work part time while searching for a full time position declined slightly to 15.8% and 24.4 million workers.
Private sector jobs rose by +83,000 and that was the weakest since June 2010. State and local governments cut 28,000 jobs. Government employment is down over 800,000 jobs in the last twelve months thanks to the ending of the various stimulus programs. The labor force rose by 272,000 in May as graduates attempted to enter the workplace.
Non-Farm Payroll Chart
Much of the decline was blamed on the supply chain issues from Japan. Automakers idled plants, cut shifts and laid off workers. While this caused a direct lay off of 5,000 workers at those plants it also had the trickle down affect of shutdowns and layoffs in hundreds of other U.S. manufacturers that also make components for those same cars. How many workers were ultimately impacted by the supply chain issue is unknown.
That supply chain problem is thought to be mostly over. The majority of manufacturing that was offline in Japan is now back in business although some at a lower rate due to infrastructure and power problems.
High gasoline prices were also blamed for the layoffs as business owners were quick to pull the trigger to cut costs when business began to slow. After enduring the Great Recession over the last several years those businesses did not want to undergo the same financial problems that almost ruined them before.
I think it is safe to say this soft patch is not likely to be over very quickly. There is still too much uncertainty in the economy and that breeds excessive caution. Personally I was glad to see the jobs number was not negative for May but I will be really surprised if it stays in positive territory for June given the predominately negative economic sentiment.
On the bright side the ISM Services Index actually rose slightly for May to 54.6 from 52.8. Quite a few people were worried the index could have slipped closer to 50 or even slightly into negative territory since the services sector is greatly impacted by higher fuel prices. To actually post a gain was a minor victory.
New orders rebounded from 52.7 to 56.8 but failed to recover even half of the -11 points they lost in April. The new orders component was over 64.1 for three consecutive months before crashing in April. Order backlogs were basically flat at 55.0 from 55.5 in April.
Some analysts saw the uptick in the ISM Services index as a sign the current soft patch will be transitory and not turn into a recession. However they do expect a decline in Q2 GDP to something less than +1% growth.
ISM Services Chart
Next week's economic calendar is very short. The only major economic report is the Fed Beige Book on Wednesday. This is the Fed survey of economic activity in all 12 Fed regions. The April Beige Book showed the recovery was broadening across all regions. Manufacturing was strongest but it was expanding to other industries while consumer spending was increasing. After scanning the various economic reports since April 13th we have to wonder exactly what the Fed researchers were drinking to come up with those conclusions. Let's hope they are still drinking the Kool-Aid and it shows up in their report this week. Obviously it appears on the surface that economic activity hit a brick wall at the end of April or early May. Needless to say this will be a highly watched report.
Other events of note will be a speech by Dallas Fed President Richard Fisher on Monday on monetary policy and financial stability. Fisher is a hawk and favors a tighter monetary policy. On Tuesday Ben Bernanke will speak about the economy. Both speeches should be market worthy.
Where are we going from here? The Fed has to be very nervous right now with their QE2 program ending this month. It was already a forgone conclusion they would continue buying treasuries with the payoff funds from prior purchases as they matured but now it appears they need to take some further action to prevent the economy from backsliding. The chance of a rate hike has moved from Q1 to well into 2012 and the Fed will need to remain super accommodative for the rest of the year if not longer.
The administration is stuck with rising unemployment and a potentially declining economy and the lack of any existing program they can use to move it forward. Stimulus is a four-letter word and lawmakers are not going to authorize any kind of package that includes more spending. Since FDR no president has ever won reelection with unemployment higher than 7.2% so the frying pan is definitely heating up.
The Fed is also stuck between consumer sentiment and political expediency. While Bernanke may want to apply more policy accommodation they have few acceptable tools at their disposal. They can't lower rates any further. They can't announce a QE3 because QE2 raised the price of commodities to the point where food and fuel inflation is in the +30% range and it would not be politically acceptable. About the only tool left would be to charge banks interest for funds they have on deposit at the Fed. This would force the banks to put the money to work in the private sector but that also assumes they could find credit worthy businesses that wanted to borrow money in a weak economy.
The future is definitely clouding up and the only way out of the mess may be to just board up the windows and let it blow over. Many theorize if the government and Fed had allowed that to happen in 2008-2009 and not bailed everyone out we would already be in a strong recovery. I disagree with that view but it is immaterial today. We are here and the economy appears to be declining again despite the trillions of dollars the government threw at the problem. We can't continue to throw money at the problem or we will end up with the same fate as Greece only there will be nobody to bail us out.
Over the next few months some hard decisions need to be made by the administration, lawmakers and the Fed. Some of them will not be politically palatable but they will still need to be made. If it were easy everybody would be a politician.
The good news is that eventually we will pull out of this slump. The bad news is that when we do and GDP growth starts moving over 3% again we will accelerate right into the coming oil recession. The only thing that is keeping it from happening today is our slow growth. If our oil demand grew to where it should be in a 3.5% to 4.0% GDP growth economy our oil demand would increase by 1.0-1.5 million barrels per day. That is the current limit of excess capacity. At the same time India and China are also growing demand by some monster numbers. Make no mistake, once our economy kicks into high gear there will be an oil slick just around the bend to run us into the ditch again.
In stock news Research In Motion (RIMM) declined -3.6% after a research report showed the BlackBerry maker fell from a 30.4% market share to 25.7% and moved from second place to third place behind Google (36.4%) and Apple (26.0%). UBS and Sterne Agee both cut price targets on RIMM and reiterated a neutral rating. The new BlackBerry Bold touchscreen model was announced for a summer delivery but is now expected to slip into September. The brokers warned Apple's upcoming iCloud service could cost RIMM even more market share as enterprise customers move to the iPhone and iPad.
Cisco (CSCO) shares hit a new two year low after DragonWave (DRWI) slashed guidance due to customers deferring significant shipments into the future. DRWI shares fell -6%. DRWI is only vaguely related to Cisco but any negative news in the sector appears to be an excuse to sell Cisco shares. I don't know if you remember the big Cisco bull that appeared on CNBC constantly back in late 2000 saying I will buy all the Cisco shares you want to sell me at $60. Hopefully all that paper is keeping him warm at night because it will be a long time (if ever) before Cisco is back over $60. Meanwhile Brocade (BRCD) closed flat for the day but held its gains from Thursday after rumors broke that Dell may be readying an offer for the networker.
Consumer stocks took a hit on Friday because of negative sentiment over the jobs report and its potential impact on consumer spending. The decline accelerated after Newell Rubbermaid (NWL) cut its full year profit forecast to $1.60 from $1.67. Analysts were expecting $1.69. Newell sells things like Sharpie pens and plastic storage containers. Newell said slumping sales in the USA were to blame. The stock declined -12% on the news but the damage was sector wide. Newell sells low dollar products while companies like Whirlpool (WHR) sell higher dollar products. Whirlpool declined -5% on the jobs and Newell news.
I hate to be the bearer of more bad news but the second quarter is rapidly drawing to a close and we are approaching the start of earnings warning season. This is the part of the earnings cycle where corporations pre announce guidance for the quarter. Texas Instruments will lead off this cycle on Wednesday when it gives its mid-quarter update.
The update will be webcast at 4:PM ET on Wednesday. Last quarter there were some questions about slowing sales to major companies like Nokia. With Nokia recently adding its own soft sales comments there could be some problems with revenue in the forecast. You can listen to the webcast here
On the positive side of the ledger the Apple Developer Conference will be on Monday and Steve Jobs will be the keynote speaker at 1:PM ET. Jobs is expected to announce more details about the iCloud and discuss deals to license music from the four major music labels. Rumor has it that Apple paid these companies $150 million for the rights to store music in the iCloud for use on any consumer device.
In related news Apple has filed a patent for a technology that turns off camera phones while at concerts so concert attendees cannot video the concert and share it illegally. When a camera phone is pointed toward the stage an infrared signal from the stage disables the camera. The patent was filed in 2009 and published by the U.S. patent office on Thursday.
OPEC meets in Vienna on Wednesday to discuss production targets for the rest of the year. This was shaping up to be a contentious meeting after Iran's president Mahmoud Ahmadinejad fired the country's oil minister and said he himself would be the delegate to the OPEC meeting. Iran currently holds the one-year rotating presidency of OPEC. To have Ahmadinejad show up as the acting president of OPEC when Iran is the arch enemy of several OPEC countries would have been interesting theater. However, he was slapped back into place by the Supreme Leader Ayatollah Ali Khamenei. An official in the oil ministry announced last week that Ahmadinejad would no longer be attending and a cabinet minister will be appointed to attend.
This means Ahmadinejad lost this round of his power struggle with Khamenei. It also means a more relaxed atmosphere at the OPEC conference. However, Saudi Arabia, normally a friend to the U.S. is frustrated with the way the Egypt revolution was handled and may not be so agreeable to President Obama's call to increase production. That means hawks like Venezuela and Iran will have a better chance of pressing for no production increase in order to keep prices high. With WTI oil prices clinging tenaciously to $100 that is the borderline between what could be considered high and damaging to the global economy if they go over that level and bearable and only mildly suppressive if they dip below $100.
OPEC is conscious of their appearance to the world as the reason for high prices and they should attempt to craft a post meeting statement that makes some kind of concession to price and production. Since they are currently producing about 2.5 million barrels per day over their actual quotas they could raise the quotas by that amount and the general public would think it was a major change in output even though in reality there would be no change.
Oil prices should be $115 today despite oil inventories in the USA near multi year highs. The price of Brent is the true price of oil at $115.84 today. The price of WTI is lower at $100 because of excess supplies in the center of North America that all have to funnel through Cushing Oklahoma where storage is limited. There are plenty of ways to get oil to Cushing but a lot fewer to get it out. A pipeline to the Gulf Coast is expected to be completed within two years and that will allow Cushing WTI oil to be sent to coastal refineries. That will allow WTI prices to rise to the same level as Brent and trade in unison as they always have. The recent $15 spread between the contracts is simply a function of limited storage at Cushing and a sudden surplus of crude from the oil sands and the Bakken. The Midwest surplus forces it to be sold at a discount. If the pipeline existed today the price would be $115.
When OPEC looks at the oil price/supply relationship next week they will be looking at the price for Brent. That is the price the various oil blends are indexed to for delivery to Europe and Asia. They are not looking at our $100 WTI price.
If they refuse to act in order to reduce the possibility of a global economic decline there are only two reasons. The first is the because they need the revenue so badly to bribe their citizens with stimulus programs that they are willing to risk a global recession to fund their budgets. The second reason is because they can't act. Excess OPEC capacity may have shrunk to a level where they really don't have any to spare and they are hoping the higher prices will keep demand moderated enough so they can keep up the charade and continue convincing everyone the "market is well supplied."
An OPEC advisor told me several months ago this was the OPEC plan. They wanted to let prices rise just enough to keep demand under control so nobody would know they had no material excess capacity. Recently Saudi Arabia announced a multi billion dollar effort to rush exploration and production on a key Saudi field. That sounds good on the surface but the field only has heavy sour crude and the market for that crude is very limited. Why spend billions to rush exploration on heavy sour crude if there was any other field you could produce that had oil refiners actually wanted? You would only do that if there were nothing else left that could be produced easily.
Regardless of the outcome of the OPEC meeting I don't actually expect the real production to change. This meeting is strictly political theater and excuse to appear on the world stage.
U.S. Crude Oil Chart
Last week was rough for the market. It was the biggest one-week decline for the Dow since August. It was the first five-week decline for the Dow since July 2004. The Dow and S&P closed at six-week lows. The Tuesday short squeeze was quickly sold and now it appears we are going to test some lower numbers.
The S&P tested 1300 at the open but rallied back to test prior support at 1310 midday when it appeared Greece had won some concessions and would get the required funding. That rebound was temporary and the index returned to close at 1300 and only two points off the low of the day. This should be decent support from the 1295-1300 level. However, with market sentiment turning increasingly negative I don't have a lot of hope we will see a sudden turnaround. We appear to be in one step forward, two steps backward mode. Until the economic reports start to show a glimmer of hope the fear of a second recession will continue to grow. Should we begin to see a flurry of earnings warnings and guidance cuts it could get ugly quick.
If the S&P breaks below 1295 it has risk to 1250. The long-term uptrend has broken and June is typically the third worst month of the year. Earnings warnings tend to increase in June as companies forecast summer sales.
The S&P has made a major break below the 100-day at 1318 and that could be a sell signal for some funds and institutions. The 200-day average at 1248 would be the next major challenge. Normally a break under the 200-day is a strong sell for even more funds and institutions. I don't expect that to happen unless the economics turn significantly worse.
The Dow plunged -144 points at the open before rebounding intraday but the end result was never in any doubt. The dip to the 12,104 low was a clean break of prior support at 12,200 and a retest of the April 18th low. The long-term uptrend is broken and support at the 100-day average at 12,250 is history.
The Dow did close on the bottom of its downtrend channel and could reasonably be expected to rebound on Monday but I seriously doubt the gains will hold. Overhead resistance is now the 100-day at 12,250 and downtrend resistance at 12,400.
Wal-Mart was the only Dow stock to close positive and that was due to their announcement of a $15 billion stock buyback. They declined -$2 over the prior two days so a +11-cent gain on Friday's news was inconsequential.
The Nasdaq followed the other indexes lower with a solid break of the 100-day. The Nasdaq is still in its downtrend channel with support at 2725. The Apple Developers Conference on Monday should give a lift to the stock and help support the Nasdaq. However, tech stocks are under pressure as every PC maker whines about lower PC sales. That impacts semiconductors and networkers. It is possible Steve Jobs could say enough positive on Monday to produce a tech rally but I doubt it would last. Tech stocks generally dominate the June warnings cycle.
The Russell 2000 was the biggest loser for the week at -3.3%. Small cap investors are beginning to run for the exits. A break of support at 810 should target a retest of the March lows at 775. That would be a major breakdown of the trend but entirely possible. Based on the Russell chart I believe fund manager sentiment has turned negative.
Dow Transports Chart
Despite the negative charts above and my expectations for lower lows that does not mean there won't be bounces in our future. June is normally choppy as far as trading because of the lower volume and the earnings and guidance warnings. Be prepared for anything.
We also have to remember that the current economic soft patch has some underlying reasons that are one-time items. The impact from the Japan quake is moderating and should be over soon. The spike in crude prices due to the loss of Libyan production has now been factored in and prices have declined somewhat. The closer we get to the end of Gaddafi's presidency the more prices will decline even though production will take many months to resume. The market will discount that resumption immediately upon Gaddafi's exit.
The European debt crisis could be seen as a one-time event even though it has been a recurring nightmare. The major problem is Greece and the EU appears to be on the verge of solving that problem with the new agreement. That means Greece will go on the back burner and the EU successfully kicked the can a little further down the road.
QE2 was another one-time event that is coming to a close this month. Uncertainty over the Fed's direction at the end of June should be cleared up at the FOMC meeting on June 21st. That will be another point of indecision we can put behind us.
The resolution of the debt-ceiling problem in the U.S. will be market positive. Unfortunately we may have to undergo two more months of brinksmanship by lawmakers before it is resolved. You would hope that the disappointing jobs report and the warning by Moody's would be an incentive for lawmakers to resolve it sooner rather than later.
On the bright side the Q1 earnings showed a +10% growth rate in revenue for S&P-500 companies and earnings grew by +18%. Outside of the financial sector and the construction sector the rest of the S&P is doing fine. Analysts are predicting record earnings for the S&P of $100 for the full year. After Q1 earnings the S&P is trading today at a PE of 13.3, which is very reasonable. There are plenty of opportunities and the economic outlook is not as grim as it would seem on the surface. If we start seeing some of the June economics rebound from their May levels we could quickly find a market bottom. Maybe not an immediate rebound but at least a bottom.
The Dow and S&P may have declined for five straight weeks BUT they are only -4% off their closing highs from April. Four percent is nothing. If good news broke out we could erase that drop in very short order. However, a -4% drop is also nothing on the downside. A real correction to -10% would be 1227 on the S&P. I seriously doubt we will see that level but I could easily see a dip to 1250 just because of the calendar period and the negative news. Let a few positive data points appear and sentiment could change very quickly.
I would continue to be cautious. Enter passively, exit aggressively.
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