Tuesday, July 06, 2010

Jobless Report

If the jobless report last week did not cause you concern, consider the following argument. Could it trigger a “second leg down” that could be more challenging than the first.

Last week the U.S. Department of Labor reported that employers cut 125,000 jobs last month, the most since October. The loss was driven by the end of 225,000 temporary census jobs. Businesses added a net total of 83,000 workers, the sixth straight month of private-sector job gains but not enough to speed up the recovery. Unemployment dropped to 9.5% - the lowest level since July 2009 - from 9.7% the month before. The decline was the result of more than 650,000 people giving up on their job searches and leaving the labor force. People who are no longer looking for work aren't counted as unemployed. The latest figures suggest businesses are still slow to hire amid a weak economic recovery. The unemployment rate and payroll figures can sometimes move in different directions because they are calculated from different surveys. The jobless rate is derived from a survey of households, while the payroll calculation is drawn from a separate survey of businesses.

With the economic recovery in an apparent stall, investors must consider the prospect of a “second leg down” in the U.S. equity markets. The first leg down began with a dramatic drop in October 2008, with a nearly continuous decline to the trough in March 2009. Since then the market has made solid, steady progress with only one temporary interruption in January and February 2010. Since the peak in April 2010, the market has been spooked by rising concerns for sovereign debt defaults in Europe. Valuations of U.S. companies have also been weakened by dismal housing, employment and production reports for the U.S. economy.

We acknowledge that the small correction in early 2010 was also triggered by weak economic reports. What is different in this round of disappointing news is the addition of sovereign debt concerns. A second facts is the uncertainty in the energy markets created by one of the worst environmental disasters in history - BP’s deep water oil well debacle. A weakened economy is not in a position to absorb many shocks, if any at all.

We also believe that U.S. consumers and U.S. investors are not in a position to absorb more bad news. For many, savings are depleted. Furthermore, many have been unemployed for so long that job skills have begun to erode. It is not surprising that have a half million people have left the job market as those who have been met with defeat after another begin to lose confidence in their ability to handle a job even if it is offered.

It is not likely that the U.S. can “spend” the economy out of the inevitable downward spiral that follows persistent unemployment. Consequently, we believe the current downturn in stock prices will not be a repeat the “temporary” sort observed in April 2010. Rather it is the beginning of a long and deep decline that will ultimately be considered the “second leg down.”

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