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Stocks edge lower on weak May jobs report

Service to others is the rent you pay for your room here on earth. – Muhammad Ali

The major stock averages ended the week close to the flat line as the weak May employment report almost certainly eliminated any chance that the Federal Reserve will raise interest rates at its meeting later this month. Based on stronger economic data in the prior week as well as more hawkish Fed minutes from its April meeting and remarks from several Federal Reserve presidents, the odds had increased substantially for a rate hike in June. But those odds immediately dropped after the release of the jobs report. The Labor Department announced that only 38,000 jobs had been created in May, far fewer than the 162,000 jobs that had been expected. To make matters worse, the jobs’ numbers for the previous two months were also revised sharply lower. While the unemployment rate declined to 4.7% from 5%, this drop was primarily the result of over 600,000 people leaving the workforce as the labor participation rate fell to nearly a 40-year low. The only bright spot in the employment report was wage growth as wages grew 2.5% on an annualized basis. The market’s initial reaction to the report was really not surprising as the Dow Jones Industrial Average plunged by triple digits. However, by the closing bell on Friday, the market had erased most of its losses and ended the day only modestly lower. This reversal might have been due to several factors. The employment report was just one piece of economic data and both the ADP private sector payroll report and the weekly jobless claims number last week painted a much more sanguine picture of the labor market. The disappointing jobs report also reduced the possibility of a Federal Reserve interest rate hike in June, which is something that investors had been fretting. The yield on the 10-year Treasury fell to 1.70% and the dollar traded lower, a trend that could continue in the near-term. This trend might be a blessing in disguise for the markets as a weaker dollar could bolster the price of oil and provide a boost for corporate profits, a condition that is needed for stocks to post additional gains.

Last Week

As mentioned above, jobs data was mixed last week as the ADP private sector payroll report added 173,000 new jobs while the weekly jobless claims fell to 267,000, the 65th consecutive week that claims have been below 300,000, a sign of a healthy labor market. U.S. consumer spending was better than expected in April and registered its biggest increase in more than six years, surging 1%. The May ISM manufacturing index also expanded for the third straight month and April factory orders recorded their biggest increase in six months. The economic news wasn’t all positive, though. Construction spending in April dropped by nearly 2%, the largest drop in over five years, and the ISM non-manufacturing index or services sector index came in less than expected. The Chicago purchasing managers index (PMI) in May fell to its lowest level since February and was below estimates as businesses remain pessimistic about the outlook for the economy.

The Fed Beige Book indicated that most Federal Reserve districts in the country were seeing only “modest” or “moderate” growth through the end of May. In overseas news, the European Central Bank (ECB) left interest rates unchanged but ECB President Mario Draghi left open the possibility of additional stimulus. OPEC failed to reach an agreement on reducing oil production but U.S. crude oil inventories dropped for the week and oil ended the week at just under $49 a barrel.

For the week, the Dow Jones Industrial Average slipped 0.4% to close at 17,807 while the S&P 500 Index ended flat at 2,099. The Nasdaq Composite Index edged up 0.2% to close at 4,942.

This Week

It will be a very slow week for economic data with the June Michigan consumer sentiment index expected to fall slightly as consumers remain cautious about the outlook for the economy and the labor market. Federal Reserve Chair Janet Yellen is scheduled to give a speech on Monday and could provide clues about whether or not the Fed plans to raise interest rates after the weak May jobs report.

Earnings reports will also be sparse this week as Casey’s General Stores, Verifone Systems, H&R Block and J.M. Smucker are among the few companies on the agenda.

Portfolio Strategy

There are a number of significant potential market-moving events this month and three of them occurred last week. The outcomes of both the European Central Bank (ECB) meeting and the OPEC meeting produced no surprises and were as expected. The ECB has already implemented a massive bond buying program to stimulate the economy and there are signs that it is working. Although the ECB left interest rates unchanged, it’s possible that further easing could occur later in the year if growth does not improve. Expectations for an agreement by OPEC to limit oil production were also low as member countries have different agendas and find it difficult to reach a unanimous decision. The biggest surprise last week was the dismal May employment report, but investors chose to view it as an aberration and looked at the benefits of a weaker dollar on corporate profits. Next on the calendar in June is the Federal Open Market Committee (FOMC) meeting on the 14th and 15th. In light of the weak jobs data, it is now highly unlikely that the Fed will pull the trigger to raise rates. Soon after the Federal Reserve adjourns, the Bank of Japan meets to review its monetary policy. Like the ECB, the Bank of Japan has also put into place a massive bond buying program to jump-start its sluggish economy. While no action is expected at this meeting, the probability of additional stimulus measures is relatively high unless economic growth accelerates. The last major hurdle for the markets this month will be the Brexit vote on June 23rd that will determine whether or not the United Kingdom remains part of the European Union. Recent polls show stronger support for remaining in the union but a number of voters are undecided. A vote to exit the European Union could have political and economic consequences and lead to a decline in GDP due to reduced trade. Whatever the outcomes are for these remaining events, there is likely to be increased volatility in the markets through month-end.