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Game Changer? Jobs Report Puts New Scrutiny On Economy, Fed Strategy

June 6, 2016

(Monday Pre-Market) Does Friday’s disappointing May jobs report dramatically change the U.S. economic outlook? And how will it shape the Fed’s strategy going forward? Those are questions that many investors might be pondering in the days ahead.

One obvious question is whether the weak jobs number, with just 38,000 positions added in May, could influence the Fed’s decision on rates. If the futures market is any indicator, the answer could very well be yes. Chances of a June hike fell to 4% shortly after the jobs data, down from above 30% earlier last week, according to CME Fed-funds futures. So the market is basically writing off any chance of a rate rise when the Fed meets June 14-15.

Odds for a July hike stand at 37%, down from more than a 60% chance forecast just days ago. There isn’t a 50-50 chance of a rise in rates until September, according to the futures market. Fed officials have been saying they’ll watch data to see if a hike is needed, so it will be interesting to see how they react to Friday’s numbers, especially on Monday when Fed Chair Janet Yellen is scheduled to speak around midday. The jobs report puts even more focus on what Yellen might say.

Another question the report raises is whether the U.S. economy has really recovered from its winter slump. Falling employment in the key construction and manufacturing industries is certainly a cause for concern. Though the U.S. is no longer an economy dominated by manufacturing, it’s always a constructive sign to see job growth in that sector.

The May job data can be added to other concerns about the economy, including sluggish Q1 gross domestic product (GDP) growth of 0.8%, falling earnings, and downward revisions to jobs numbers from March and April. The government revised payroll growth for March and April by a combined 59,000 positions, and the economy has averaged job growth of just 116,000 for the March-May period compared with well above 200,000 per month throughout 2015. That’s not a positive sign, to say the least.

But all of that weakness contrasts with recent strength seen in housing and consumer spending, making it a bit difficult to get a sense where the economy really stands. One indicator that bears watching to interpret the full impact of all the data is The Atlanta Fed’s Q2 GDP estimate, which was lowered Friday to 2.5%, down from 2.9% a week ago. Some analysts forecast less than 2% growth.

The 2100 level remains a key technical benchmark for the S&P 500 index (SPX). If the market can post a few closes above that level, it could act as a launch pad for future rallies. It’s also important to keep an eye on Treasury yields, which fell sharply Friday after the jobs report. The 1.8% mark for 10-year yields appears to be a technical resistance point.

But it could be hard for the equities market to rally without the help of the financial sector, which was the hardest hit as of midday Friday. Financials had been doing better of late, partly based on hopes for a rate hike, but the jobs report certainly seems to have put a damper on that outlook. Looking at the market’s history, it’s very hard to rally without the financial sector rallying and being a leader. Biotech stocks are another sector to watch. The biotechs have had a really healthy upward move lately, but the election is approaching and biotech is among the most heavily regulated industries. That could raise some concern about the sector’s performance in the months ahead.

This coming week is a little light on data, but the Yellen speech certainly makes up for that. One number to look for is Wednesday morning’s “JOLTs” report on job openings, a data point the Fed typically monitors. But it’s a two-month trailing number, so it may not mean too much.

S&P 500


The S&P 500 (SPX), plotted through midday Friday on the TD Ameritrade thinkorswim platform, keeps pivoting around the 2100 level. Closing above that level could conceivably set the stage for future rallies. Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

Any Silver Lining? Those looking for silver lining in Friday’s disappointing monthly jobs report certainly faced a challenge. One positive was strong growth in health care employment, where the economy added 46,000 jobs in May. Mining employment was down, but that industry has been reeling for some time due to weakness in commodities markets, so a drop wasn’t much of a surprise. Wages actually grew slightly during the month, a step in the right direction. It’s tempting to look at the headline unemployment rate of 4.7% as another positive, since it was down from 5% previously. But that actually may not be so hot, because it can often signal disenchanted workers dropping out of the labor force. A fall in the workforce participation number to 62.6% in May seems to bear that out.

Stampede Away From Risk Follows Jobs Data: In the wake of Friday’s weak jobs data, investors appeared eager to embrace some less risky assets. Gold, which had been slumping, surged more than 2% to above $1,240 by midday, its highest level in more than a week. Treasuries also rallied, sending the yield on U.S. 10-year Treasury notes down to just above 1.7%, the lowest level in three weeks. Meanwhile, the dollar, which had been climbing lately on expectations of a possible Fed rate hike this summer, gave up some of those gains, falling against both the euro and the yen. While low-risk assets rose, the financial sector took a blow, falling nearly 2% by midday. The jobs report wasn’t the only data to disappoint on Friday. ISM non-manufacturing came in at 52.9 for May, well below April's 55.7 figure. The employment component fell to 49.7 from 53.0 in April.

Updated Look At Valuations: As of midday Friday, the S&P 500 index (SPX) was up a solid 15% from its mid-February low. The strong gains came despite a very poor Q1 earnings season in which earnings for S&P 500 companies fell nearly 6% in aggregate. And Q2 earnings aren’t necessarily looking like they’ll help the picture, with S&P Capital predicting a 5% year-over-year decline. Slow earnings growth and the quick stock market recovery helped combine to send the SPX’s price-to-earnings ratio to nearly 18 based on estimated 2016 earnings, which is above historical averages, and a high P/E ratio for the SPX typically reflects optimism about the economy. But Friday’s jobs data and the downward revisions to previous jobs numbers put a different spin on how the economy is performing. Could this cause some investors to take another look at whether current high valuations are justified?

Good Trading,

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