Thursday, April 8, 2010

Market Update - April 4, 2010

The big economic news of last week was the release of the March employment numbers which showed an increase of 162,000 jobs.

Jobs Growth

The employment numbers reflected the first increase since March 2007 and the report is being touted as the final signal in the turn around of the economy following the “Great Recession.”

I for one am thrilled to see a positive number. However, my thrill is tempered by the fact that since the recession began, 8.5 million Americans have lost their jobs. At the current growth rate it will take until 2022 before those lost jobs are gained back. I am not suggesting that this will be the case, but I am saying that we need substantially greater job growth, especially in the private sector, before we start popping corks. As I have been saying in previous updates, we need to see this trend sustain itself. The overall unemployment rate remains at 9.7% and the number of long-term unemployed (greater than six months) has grown to just over 40%. The Fed is projecting overall unemployment to drop to just 8.3% by the end of 2011. Additionally, 48,000 jobs came from temporary census employment and another 40,000 were categorized as temporary. One important point is that historically, temporary jobs begin to expand ahead of permanent employment as companies cautiously expand their payrolls.

The stock market’s reaction can be expected to be positive for all the right reasons and will likely continue the on-going steady increase in all the major market indexes. For the week, the Dow Jones Industrial Average closed up 77 points (0.71%) to 10,927.07. Investors are watching closely as the market approaches the 11,000 level. There is nothing technically significant in the 11,000 number, but there is always a psychological boost when a big number is exceeded. The S&P 500 did slightly better last week gaining a little more than 11 points to close at 1178.1 (0.99%).

For bond investors the jobs report is likely to put pressure on bonds. US treasuries weakened on the news as the 10-year treasury yield closed at a 17-month high at 3.9426% from last week’s close of 3.8545%.

Oil Price Climbs

Somewhat quietly, oil futures pushed up nearly $5 per barrel to close the week at just under $85.

Oil buyers are suggesting that improving global economic data, especially in China and the Far East, will drive greater demand. However, there are conflicting opinions about whether or not the price of oil will continue to rise. For starters, the U.S. Energy Information Administration reported last week that gasoline inventories reached a 17-year high in late March, while oil stockpiles continued to rise as well. OPEC is sitting on 6 million barrels of excess spare capacity which they are likely to tap if oil prices rise too much. The Saudis have said that from their perspective they see the ideal price to be between $70 and $80 per barrel. So I will continue to watch this tug-of-war between supply and demand as the summer approaches. The Oil Sector is currently unfavored by my technical analysis; however, if prices continue to rise, I expect to see opportunity here.

Greece

I continue to watch Greece’s struggle with interest because of its potential impact on the international markets and as an illustrative example of a country’s battle with mounting debt and internal political conflicts.

Greece must issue more than €20 billion ($27 billion) of new debt in April and May to replace maturing bonds. Additionally, there is the possibility of another €10 billion ($13.5 billion) debt offering in the near term to meet on-going needs. The global credit markets will likely require even higher interest rates to take on this debt adding additional budgetary stress as they replace older and cheaper debt. The Euro closed Friday at $1.3483 which was a slight increase of $0.0021 from the previous Friday’s close. Analysts reported that the Euro would have been stronger had it not been for concerns over Greece’s on-going debt worries.

In general, international equities had a good week. The MSCI EAFE (World) index closed up 32 points (2%). For the year the index is up just 1.5% compared to the S&P 500 which is up 5.6% for the year. International stocks remain unfavored, but if last week’s gains continue, that may change.

Looking Ahead

The markets continue to show strength both domestically and globally. I remain cautiously optimistic that these gains will continue for now. Small and Mid Cap stocks continue to be favored over Large Cap stocks—a relationship that has been in place since the markets began their turnaround a year ago. I am adding Financials into my favored sectors along with Real Estate, Consumer Discretionary, Information Technology, and Materials.

Bonds have also rallied dramatically over the last year; however, their momentum has clearly waned. The Dow Jones Corporate Bond Index closed the week at 108.41 up 0.44 (0.41%). The index has failed three times since last September to break through 109.38 and continues to trade in a narrow band. US treasuries have shown the greatest weakness especially in the longer maturities. Barring a major international incident, I believe this trend will continue. Bond futures market have priced in an 84% likelihood that the Fed will increase the Fed Funds rate to 0.5% (up from 0% to 0.25%) when they meet in November. I do not believe this will have a negative impact on the equity markets, but I do think long-term treasuries will continue to weaken. Currently Corporate Bonds and International Bonds remain favored.

Paul L. Merritt, MBA, CRPC® Principal

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