December employment report disappoints investors

The markets generally are unpredictable, so that one has to have different scenarios. The idea that you can actually predict what’s going to happen contradicts my way of looking at the market. – George Soros, American business magnate, investor and philanthropist

In a surprise announcement that caught most market observers and investors off guard, the government said that only 74,000 new jobs had been created in December, well below the estimate of 200,000 non-farm payroll jobs. What made the number more shocking was that it was released after payroll processor Automatic Data Processing (ADP) said that 238,000 private sector jobs were added in the month and after U.S. jobless claims fell to a five-week low on Thursday. While the unemployment rate fell in December, the decline was attributed partly to many people dropping out of the labor force as the labor participation rate declined to its lowest level in 36 years. In fact, another measure of employment, the U-6 report, looks at the unemployed, underemployed and discouraged and says that the real unemployment rate is 13.1% based on these measures. In any event, the stock market chose to disregard the disappointing news as a statistical fluke caused by abnormally frigid temperatures during the month. It’s also possible that when the jobs number is reviewed and revised, it could show marked improvement in coming months. For the most part, the overall economy has been steadily improving and investors chose to acknowledge this fact rather than focus on one economic report.

Last Week

Although the employment report on Friday was definitely disappointing, the other economic data released last week was positive. The U.S. trade deficit declined significantly to a four year low as exports surged and weak oil prices held down imports. This surprisingly good number bodes well for stronger GDP growth in the fourth quarter. In addition to the strong ADP jobs report that saw strength in both manufacturing and construction jobs, a well-known outplacement firm said that announced layoffs fell to the lowest level in a year. This report indicates that firms are becoming increasingly more confident about the prospects for the economy.

In other news, release of the Federal Reserve minutes from their last meeting showed that the Fed tapered because they believed that the benefits of the policy were eroding over time. They also were almost unanimous in their belief that an improving economy could withstand gradual withdrawal of the monthly stimulus. Overseas, the European Central Bank agreed to maintain its easy monetary policies and kept interest rates at record lows.

For the week, the Dow Jones Industrial Average declined 0.2% to close at 16,437 while the S&P 500 Index rose 0.6% to end the week at 1,842. The Nasdaq Composite Index climbed 1% to close at 4,174.

This Week

This promises to be a busy week of economic news, starting with retail sales for December, which should increase modestly despite heavy discounting and promotional activity by retailers. Both the December producer price index (PPI) and consumer price index (CPI) are also on tap and although both are expected to increase, the core rate that excludes food and energy is only forecast to rise 0.1%. Housing starts and industrial production for December are among the other releases next week and both should confirm an improving housing market and manufacturing sector.

Earnings reports for the fourth quarter will be begin in earnest this week and the big banks and financial services firms will take center stage as JP Morgan Chase, Wells Fargo, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley are all scheduled to report. Other prominent companies due to release earnings include Intel, General Electric and Schlumberger.

Portfolio Strategy

Just as investors were getting comfortable with a yield of about 3.0% on the 10-year Treasury, the weak jobs report caused the yield to fall sharply to 2.86%. The recent stronger than expected economic data had caused many investors to believe that the new range for the 10-year Treasury yield was between 3.0% and 3.25%. Proof of the improving economy was never more evident than in the Fed’s decision to begin tapering its stimulus program last month. The importance of the employment report cannot be underestimated as Treasury yields experienced their biggest drop since September on the news. With the inflation rate running at 1.2%, well below the Fed’s target of 2%, it appears that Federal Reserve policy will maintain its targeted interest rate at between 0% and 0.25%. For fixed income investors, this means that bonds and bond funds should be purchased with average maturities of less than five years in order to limit any possible interest rate risk. Corporate notes offer a yield advantage over Treasuries due to their extra credit risk and for investors in higher tax brackets, intermediate-term municipal bonds are cheap and offer good value. While the expectation is for interest rates to gradually rise throughout the year, weak economic data along the way such as Friday’s jobs report can serve to depress yields.