MarketView for August 2

 

 

Summary

 

The Dow Jones Industrial Average and the S&P 500 indexes ended at record highs for a second consecutive day on Friday, posting modest gains despite a mixed employment report that showed hiring slowed in July.

 

The jobs report indicated that non-farm payrolls rose by 162,000 in July, well below expectations. Yet, the unemployment rate fell to 7.4 percent, reaching its lowest point since December 2008. The mixed data could make the Federal Reserve more cautious about scaling back its massive economic stimulus.

 

The tepid report follows a series of better-than-expected data and optimism about strong growth in the second half of the year.

 

Among the largest drags on both the S&P 500 and the Dow was Chevron, the second-largest domestic oil company. Its shares fell 1.2 percent to $124.95. The company posted a steeper-than-expected 26 percent drop in quarterly earnings.

 

Stocks bounced late in the day after trading mostly flat, and both the Dow and S&P 500 also reached intraday record highs.

 

Second-quarter earnings have mostly exceeded expectations, with the season in its final innings. Of the 391 companies of the S&P 500 that have reported, 67.8 percent have topped analyst expectations, in line with the average beat over the past four quarters, data from Thomson Reuters showed. About 55 percent have reported revenue above estimates, more than in the past four quarters but below the historical average.

 

LinkedIn rose10.6 percent to $235.58 and several brokerages raised their price targets on the stock after it exceeded expectations.

 

Dell's special committee and a group led by founder and Chief Executive Michael Dell announced a deal that dramatically increases the chances of his $24.6 billion buyout going through. Dell shares gained 5.6 percent to $13.68.

 

Among the day's losers, shares of Time Warner Cable fell 0.5 percent to $117.10 after news that Cox Communications held talks about merging with cable provider and rival Charter Communications. Charter added 4.7 percent to $134.

 

Approximately 5.68 billion shares changed hands on the three major equity exchanges, a number that was below the average daily closing volume of about 6.4 billion shares this year.

 

Hiring Rate and Unemployment Rate Decline

 

Employers slowed their pace of hiring in July but the jobless rate fell anyway, a pair of mixed signals that could make the Fed more cautious about drawing down its huge economic stimulus program. The number of jobs outside the farming sector increased by 162,000 last month, the smallest gain in four months and was well below Street expectations.

 

The lackluster reading reinforced the view that the job market is only inching toward recovery from the Great Recession and weighed on financial markets. At the same time, gains in employment were enough to push the jobless rate down to 7.4 percent, its lowest level since December 2008.

 

However, the report was full of details that cast the declining jobless rate in a poor light, and raised doubts over whether the economy has improved enough for the Fed to begin reducing bond purchases at its next meeting in September.

 

For one, part of the drop in unemployment was due to a decline in the size of the U.S. workforce, which only includes people who have jobs or are looking for work. The workforce can shrink when more workers retire or go to school, but it also contracts when people give up the job hunt.

 

Also robbing some of the report's luster, Americans on average worked shorter work weeks in July, while hourly wages fell. That bodes poorly for future consumer spending, the engine of the U.S. economy. The construction industry shed 6,000 jobs. The government also said 26,000 fewer jobs were created in May and June than previously estimated.

 

Policymakers also might take comfort in a pace of hiring that at least appears to be steady. The jobless rate has fallen eight tenths of a point in the last year. Beyond the report's implications for policy, a deeper question is whether the pace of job creation can be sustained given weak economic growth.

 

Gross domestic product, a measure of the nation's economic output, grew at a mere 1.4 percent annual rate in the first half of the year, down from 2.5 percent in the same period of 2012. Most economists expect GDP will accelerate in the second half of this year, which would make it more plausible for the current hiring trend to continue.

 

But the fact that the jobless rate has fallen steadily despite weak output might point to a frightening possibility: perhaps the U.S. economy's growth potential has fallen.

 

This would mean less output is needed to create jobs, but that incomes would grow at a slower pace over the long run. The prospect of such a structural shift worries economists and investors.

 

Friday's report could fan those concerns. The average work week declined to 34.4 hours in July, while average hourly earnings slipped 0.1 percent.

 

The report also showed 5.7 percent of Americans who had jobs in July could not get enough hours to qualify as full-time workers, the same percentage as in June. While the unemployment rate has fallen steadily over the last year, the share of part-time workers who want more hours has barely dropped.

 

Also, the number of long-term unemployed, while falling, remains historically high. Bernanke has warned this situation could deal lasting damage to the economy's growth potential. That is because people out of work for extended periods might never work again. In July, 4.25 million Americans had been unemployed for at least six months.

 

Other data on Friday indicated a slight gathering of inflationary pressure, with the 12-month reading of the Commerce Department's gauge of core inflation rising to 1.2 percent in June from 1.1 percent a month earlier. That could allay some concerns at the Fed that extremely low inflation could hurt the economy by giving consumers more reason to put off purchases.

 

Dollar Falls on Economic Data

 

The dollar slumped against the euro and the yen on Friday as varied signals regarding the labor market lessened expectations the Fed would start reducing its bond purchases as early as next month.

 

Those bullish on the dollar were disappointed after data showed the jobless rate fell in July but hiring slowed, in mixed signals that could make the Fed more cautious about scaling back its monthly $85 billion bond buying program.

 

Employers slowed their pace of hiring in July, with job growth of 162,000, the Labor Department said on Friday. That was below the median forecast in a Reuters poll of 184,000. The jobless rate fell to 7.4 percent.

 

After a string of better-than-expected data this past week that buoyed optimism about economic growth in the second half of the year, the tepid jobs data served as a reminder that the recovery faces headwinds. Expectations that the Fed may start winding down its monetary stimulus program as early as September have buoyed the dollar this year.

 

Those hopes have faded a bit in recent weeks and the Fed on Wednesday offered no indication of a near-term move at the end of a two-day policy meeting. A smaller stimulus program could prod a rise in interest rates, potentially making the dollar more attractive for investors.

 

On the week, the dollar was on track for a gain of about 0.6 percent against the yen, while the euro was little changed against the dollar. The dollar index .DXY, which measures the greenback versus a basket of currencies, fell 0.4 percent to 81.974.

 

Factory Orders Rise

 

According to a report released Friday morning by the Commerce Department, new factory orders rose for the third straight month in June, making it the latest indication that a recent slowdown in manufacturing activity had probably run its course. The Commerce Department indicated that new orders for manufactured goods increased 1.5 percent. May's orders were revised to show a 3.0 percent rise instead of the previously reported 2.1 percent advance.

 

Increased demand came from transportation equipment, with orders there rising 12 percent. Orders excluding the volatile transportation category slipped 0.4 percent after rising 1.0 percent in May. Unfilled orders for factory goods jumped 2.1 percent, the largest increase since December 2007, a good sign for future manufacturing activity.

 

The department also said orders for durable goods, which are manufactured products expected to last three years or more, rose 3.9 percent instead of the 4.2 percent increase reported last week. Orders for non-defense capital goods excluding aircraft - seen as a measure of business confidence and spending plans - rose 0.9 percent versus a 0.7 increase reported last week.

 

Consumer Spending and Inflation Rise

 

Consumer spending increased and inflation pushed higher in June, which could strengthen expectations that the Federal Reserve will curtail its bond purchases later this year. The Commerce Department said on Friday consumer spending rose 0.5 percent, lifted by automobile purchases and higher gasoline prices. May's increase was revised down to 0.2 percent from a previously reported 0.3 percent.

 

June's increase in consumer spending, which accounts for more than two-thirds of U.S. economic activity, was in line with expectations.

 

A price index for consumer spending rose 0.4 percent, the largest gain since February. It had edged up 0.1 percent in May. Over the past 12 months, inflation rose 1.3 percent, still below the Fed's 2 percent target. The index advanced 1.1 percent in the period through May.

 

With prices picking up, consumer spending adjusted for inflation nudged up 0.1 percent. The so-called consumer spending, which goes into the calculation of gross domestic product, had increased by the same margin in May.

 

The consumer spending numbers were included in the second-quarter GDP report on Wednesday, which showed the economy grew at a 1.7 percent annual pace after expanding at a 1.1 percent rate in the first three months of the year.

 

Spending has been held back by an increase in taxes at the start of the year, but is expected to accelerate in the second half of the year, supported by a steady jobs market and a recovery in housing.

 

The rise in inflation in June should provide some comfort to Fed officials who on Wednesday nodded to the potential dangers of inflation running too low, and bring them close to reducing the central bank's $85 billion per month in bond purchases.

 

Still, inflation remains benign. The price index for consumer spending, excluding food and energy, rose 0.2 percent in June. It was the largest increase since January and followed a 0.1 percent gain in May. Core prices were up 1.2 percent from a year ago, rising by the same margin for a third consecutive month.

 

A firming labor market is helping to prop up income, which in June gained 0.3 percent after rising 0.4 percent in May. However, government salaries fell, reflecting furloughs at agencies as part of Washington's belt-tightening.

 

With spending outpacing income growth, the saving rate - the percentage of disposable income households are socking away - fell to 4.4 percent from 4.6 percent.