Thursday, May 31, 2012 – Jobs and the Food Chain – by Sinclair Noe

DOW – 26 = 12393
SPX – 2= 1310
NAS – 10 = 2827
10 YR YLD -.04 = 1.58%
OIL +.04 = 86.57
GOLD – 2.30 = 1561.20
SILV - .22 = 27.81
PLAT +15.00 = 1421.00

The S&P 500 index fell 6.3 percent in May, its largest percentage drop since September. The Dow's 6.2 percent drop and Nasdaq's 7.2 percent loss are their largest monthly declines in two years. Crude oil futures prices finished May with losses of 17%, their worst drop (or best, depending on your position) since December 2008, near the height of the U.S. financial crisis. Gold ended May with its fourth straight monthly decline – about 6%, the most in 12 years, and only slighly better than the S&P500. The troubles in Europe sent investors looking for the safe haven of the dollar and the dollar index gained 5.4% in May. The Euro finished the month at $1.233, down 7%. The Spanish market index, the Ibex25 is down 13%, Japan's Nikkei is off 10%, and the Russian RTS is down 22% in May. The 10-year US Treasury note returned 1.6% for the month as yields dropped to historic low. If you think the markets are starting to resemble Mr. Toad's Wild Ride – you are correct. The VIX, the Volatility Index jumped 40%.

We had a few economic reports, disappointing economic reports, however the big jobs report tomorrow will overshadow today's news.

The Commerce Department reports economy grew at an annual rate of 1.9 percent in the first three months of the year; that number is a downward revision of the initial estimate of 2.2% growth. The new, lower number can be attributed to less spending by consumers and government, while businesses were slower to restock, and the trade deficit grew.

Consumer spending grew at an annual rate of 2.7 percent in the first quarter. While that was the fastest pace since the end of 2010, it was down from an initial estimate of 2.9 percent. Personal after-tax income was revised lower to growth of only 0.2%; that's down form the earlier estimate of 1.7%. And that means that consumer spending only increased because people were saving less. The savings rate fell to 3.6% of disposable income.

More demand from consumers leads businesses to step up restocking, which also boosts growth; however consumer spending was not strong and there was now need to restock shelves.

Government spending at all levels fell at a 3.9 percent annual rate. That's much more than the 3.0 percent decline first estimated. It was the sixth straight quarter that government spending has declined.

A rising trade deficit slows growth because the country is spending more on foreign-made products than it is taking in from sales of U.S.-made goods. One bright spot for the trade deficit is that oil prices have been dropping hard in the past month, which should give a slight boost.

And while it is widely anticipated that the second quarter is growing at a little better pace of 2 to 2.5%. So, the first quarter GDP number is sluggish; we need to see twice as much growth to cut the unemployment rate by a percentage point over the next year.

The unemployment rate has dropped from 9.1% to 8.1% and part of the reason is that the economy has added 1.5 million jobs since August, and 2 million jobs in the last year, which is good, but also the unemployment rate dropped because many people have dropped out of the labor market – they given up looking for a job or they've retired. The fact that hundreds of thousands of people are being dropped from long-term unemployment benefits likely means that they will no longer be counted as part of the labor market, and might skew the unemployment rate lower.

Weekly unemployment claims last week were slightly higher than expected (383K vs. 370K), but that is well within the normal level of "noise" for this series. At worst, this could be a sign that the downtrend in claims is slowing; still, the unadjusted claims number was down 10.6% from a year ago, and that is a good thing.

ADP, the payroll processing company issues a monthly report on private sector jobs; private employers created 133,000 jobs in May, fewer than the expected 148,000; the pace of hiring in private jobs has slowed. So far in the second quarter, the average monthly gain for private-sector payrolls is 123,000, compared with a pace of more than 200,000 seen for the U.S. economy in the first quarter. The ADP report is not a precise guide to tomorrow's jobs report.

Tomorrow morning, we'll get the monthly nonfarm payroll report and the consensus is for an increase of 150,000 payroll jobs in May, and for the unemployment rate to remain unchanged at 8.1%.

The numbers in tomorrow's report will indicate whether the economic slowdown of March and April was largely a statistical blip, perhaps just a weather related anomaly. A solid monthly jobs gain in May — at least 150,000, if not closer to 200,000 — would suggest that the recovery remains on track. Anything below 150,000 would suggest that Europe’s troubles, high gas prices and the continuing hangover from the American debt bubble had caused a spring slowdown for the third straight year.

Job growth of more than 200,000 in May would qualify as excellent news. Growth between 175,000 and 200,000 would be very good, while growth between 150,000 and 175,000 would still be pretty good. Anything less than 150,000 would count as a disappointment — and a sign that the strong hiring pace of early this year seems to have faded.

Also, remember to watch the revisions to the March and April numbers. As of now, the Bureau of Labor Statistics shows a gain of 154,000 jobs in March and 115,000 in April, but those numbers will be updated.

The numbers matter for businesses and job seekers, including those two guys looking for a job at 1600 Pennsylvania Avenue.

PIMCO's Bill Gross, manager of the world's largest bond fund says the debt crisis and central bank policy responses have degraded the quality and value of debt markets and signal a potential breaking point in the global economy. In his June outlook entitled "Wall Street Food Chain," Gross said stimulus policies by the Federal Reserve and the European Central Bank have led to riskier government bonds with lower value and paved the way for higher inflation.

Gross writes: "Policy responses by fiscal and monetary authorities have managed to prevent substantial haircutting of the $200 trillion or so of financial assets that comprise our global monetary system, yet in the process have increased the risk and lowered the return of sovereign securities which represent its core."

Gross writes: "Both the lower quality and lower yields of previously sacrosanct debt therefore represent a potential breaking point in our now 40-year old global monetary system.”

Gross said investors should seek higher-quality sovereign bonds in the U.S., Mexico, and Brazil with intermediate durations and stocks of global companies with stable cash flow that are exposed to high-growth markets.

He also warned that the higher risk and lower quality of U.S. Treasuries could spur investors such as China and firms like PIMCO to drop them for more profitable investments such as commodities and real assets, a move that could disrupt the current dollar-based credit system.

Gross also said, "At a 1.57 percent yield for Treasuries on the 10-year level, you'd have to think they're looking for other alternatives" such as commodities or oil, and he doesn't expect a common euro bond to be issued, but that such an event would stifle demand for Treasuries and could raise 10-year U.S. Treasury yields to 2.5 to 3 percent.

In Europe, ECB President Mario Draghi ruled out hopes that the central bank would step in to ease the pressure in financial markets as EU leaders grappled with measures to tackle structural problems in the debt crisis. Concerns over Europe's debt crisis and the lack of a clear policy response have been rising since Spain unveiled unconvincing plans to recapitalize nationalized lender Bankia. Those worries kept Spain's 10-year bond yields at around 6.6 percent, The flight from Spanish debt and Italian bonds, which are under threat of contagion from Spain, has boosted demand for the safety offered by German government paper.

Germany's two-year bonds traded just above zero percent, while benchmark 10-year Bund yields hovered around their record low of about 1.25 percent.