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The market has been difficult for investment managers focused on the big picture, in spite of the fact that problems abound. While volatile, the market has nevertheless continued to perform quite well. This period occurs when the market is said to be climbing a wall of worry, which markets will do at times when investors continue to invest ignoring daily negative issues that surface. This is not necessarily detrimental if underlying economic and corporate trends are strong or gaining strength and the weakness in the economy is, in fact, temporary. However, if underlying trends are actually weakening, then climbing a wall of worry could indeed be detrimental and foolish, representing a period of overzealousness and misinterpretations that could damage investors if the weakness continues.
What’s Over the Next Hill?
Friday’s employment data was discouraging. In fact, there was nothing about it that was pleasant to read. The ADP Employment Report on Thursday led investors and economists to believe that we would potentially see an increase of 157,000 jobs in June, which turned out to miss the mark by a long shot—18,000 would have been right on the mark! What’s more, consensus estimates called for an increase of 125,000 private sector jobs in June, and at 57,000, the actual number was less than half expectations. To illustrate the size of the downturn in the employment picture, an average of over 200,000 jobs had been added in each month between February and April. Further, the recent revisions to the May numbers are worrisome. May’s employment number was not strong to begin with coming in at 54,000 net new jobs. This was subsequently revised down further to a mere 25,000. May will still get one more revision next month before we see the final number. Any bets on what June’s revision is going to look like?
At this point we think the number that investors should also be concentrating on is the ongoing decline in public sector jobs. Everyone has been watching the private sector number closely because this is where the greatest amount of job creation has been—or had been, until the last two months. The public sector could be the harbinger of even greater bad news moving forward as local, state and national budgets continue to unravel and call for significant employment cuts at all levels. The employment report included a 39,000 reduction in June, following a 44,000 reduction in May. Given the current economic climate at just about every level of the public sector, we anticipate that this could be an extreme at-risk area for increasing losses in employment.
What could be worse than all of this? Perhaps that the overall current weakness in unemployment is broadly spread across all sectors, temporary jobs fell by 12,000—the third monthly decline in a row, and the unemployment rate has now risen to 9.2%, the highest level seen since last December completely reversing the recent trend of rising employment. The report also showed a decline in both hourly wages and hours worked.
We have now entered the third quarter and one needs to ponder where and when the second half of the year pick-up we keep hearing about will begin to occur. Friday’s employment report provides the best overall view of the economy and it paints a troubling picture of the weakness at hand. This follows other reports over the last several weeks that also illustrate cracks forming in the economy. As an example, auto sales, while previously one of the stronger consumer purchases and adding to the economic strength, have recently skid to a crawl causing auto inventories to begin to climb in recent months. In addition, other regional and national manufacturing surveys have indicated a significant slowing trend in what had been the leading engine of strength for the U.S. recovery.
Other Areas of Concern
Greece has moved beyond its initial and follow-up bailout rounds, and there are now concerns that the country may still default on its debt. In addition, Portugal’s debt was downgraded to junk-level status, and fears that Italy will soon be following in Greece’s footsteps are adding to global concerns. These events do not speak positively for a turnaround in Europe’s debt problems, and represent a situation that will likely take time to work through—should this continue to even be a possibility.
China recently announced that its manufacturing in June, as measured by its Purchasing Managers’ Index, decelerated again to a level of 50.9 from 52.0 in May—just barely above the level of 50 which indicates whether an economy is expanding or not. HSBK/Markit, in a similar independent index, reported a level of 50.1 for June, down from 51.6 in May and also supporting this weakening trend. Manufacturing in China has now declined in seven of the past eight months. Unfortunately, as China struggles to get a handle on inflation, recently reported at 6.4% and its highest level in three years, its central bank has persistently raised both the lending rate and its bank reserve requirements in an effort to slow down its economy. As a consequence, China now risks the possibility of creating a recessionary scenario should manufacturing decline further as the result of a slowing world economy.
The Administration, Fed Chairman Ben Bernanke and many economists and Wall Street analysts are forecasting a pick-up in U.S. GDP growth in second half 2011. The first half of 2011 turned out weaker than originally expected, yet many of these some individual are even more optimistic about a pick up. We believe, given current trends, that this outcome is doubtful.
The holidays are nearly six months away and our greatest concern could well be The Grinch that Stole Christmas this year. This would not bode well for 2011 and could make 2012 more challenging. However, all said, we also believe the pendulum can swing in the other direction and economic times can quickly change in a world of both unforeseen consequences and potential global cooperation. The effects of size, momentum, and velocity that can occur when playing three level chess, the essence of global economics, suggests that there are several potential outcomes.
~Mark Gaskill, Chief Investment Officer
~Julie Bryan CFA, Director of Research
