MarketView for July 5

 

 

Summary 

 

Stocks rose sharply on Friday after robust jobs data pointed to economic growth and investors overcame concerns that the Federal Reserve may begin scaling back its stimulus efforts as soon as September.

 

After choppy trading through much of the session, which was marked by light volume, stocks extended gains in late afternoon, pushing the S&P 500 index above its 50-day moving average for the first time since June 19.

 

The government's report on non-farm payrolls showed employers added 195,000 jobs in June, exceeding expectations of 165,000. Job growth in previous months also was revised higher.

 

For the holiday-shortened week, the Dow Jones Industrial Average was up 1.5 percent, the S&P 500 was up 1.6 percent and the Nasdaq composite was up 2.2 percent.

 

Although the jobs data will likely increase the possibility that the Fed will begin to reduce its QE3 program sooner than expected, the markets recovered as the data began to be thought of as a positive sign for the economy, with sectors tied to the pace of growth leading the way upward.

 

Small-cap shares and banks rallied, giving credence to the idea that investors were viewing the strong payroll figures positively.

 

The S&P Small Cap 600 index rose 1.5 percent to hit a new all-time high of 568.15 while the S&P 500 financial sector index gained 1.8 percent.

 

Bank of America Corp ended the day up 1.8 percent to close at $13.06 while Citigroup gained 1.8 percent to end the day at $48.53. Large banks benefit when interest rates rise because higher rates increase their net interest margin.

 

Interest rates rose sharply on Friday in anticipation that the Fed will start cutting its monthly $85 billion in bond buying, which was a major factor in the stock market's rally this year, as early as September.

 

Annaly Capital Management was down 5.1 percent to $11.51 as the yield on the benchmark 10-year U.S. Treasury note rose above 2.7 percent. Annaly was the fourth most-traded stock on the New York Stock Exchange.

 

Gold fell 3 percent, extending earlier losses as the dollar gained strength. Newmont Mining was the S&P 500's worst performer, falling 4.3 percent to $27.78.

 

Volume was light, with many traders still away after the Independence Day holiday on Thursday. About 4.9 billion shares changed hands on the three major equity exchanges, as compared to a daily average of about 6.4 billion shares this year.

 

Job Growth Exceeds Expectations

 

Job growth was stronger than expected in June and the payroll gains for the prior two months were revised higher, cementing expectations for the Federal Reserve to start winding down its massive stimulus program as early as September.

 

Employers added 195,000 new jobs to their payrolls last month, the Labor Department said on Friday, while the unemployment rate held steady at 7.6 percent as more people entered the workforce.

 

The government revised its count for April and May to show 70,000 more jobs were created than previously reported, a sign the economy was on solid ground, despite higher taxes, government spending cuts and signs of weakness overseas.

 

In the second quarter, job growth average 196,333 per month, in line with the 200,000 which many feel is the Fed’s monthly expectation. For the first half of the year employment averaged just over 200,000 per month. At the same time, average hourly earnings rose by the most since November.

 

The jobless rate was unchanged last month because the labor force swelled as younger Americans piled in. The Fed has said it expects unemployment to drop to around 7 percent by the middle of next year, when it anticipates ending its bond purchases.

 

It was the third consecutive monthly increase in the workforce and it lifted the participation rate - the share of working-age Americans who either have a job or are looking for one - further away from a 34-year low touched in March.

 

Declining labor force participation as older Americans retired and younger people gave up the hunt for work had accounted for much of the drop in the unemployment rate from a peak of 10 percent in October 2009.

 

An even broader gauge of the health of the labor market - the percentage of working age Americans with a job - also rose, reaching 58.7 percent, its highest level since November.

 

However, a measure of underemployment that includes people who want a job but who have given up searching and those working part time because they cannot find full-time jobs jumped to 14.3 percent from 13.8 percent in May. It is also likely that the increase reflected the long-term unemployed falling off extended jobless benefits, which have ceased in most states because of better job market conditions.

 

All the job growth was in the private sector, where payrolls increased by 202,000 after rising 207,000 the prior month. While this is encouraging, more than half of the jobs were in the retail and leisure and hospitality sectors, which typically are relatively low-paid.

 

Retail jobs increased 37,100 last month after advancing 26,900 in May. Leisure and hospitality employment rose 75,000 after increasing 69,000 in May. In contrast, manufacturing payrolls fell by 6,000 jobs, declining for a fourth straight month, while construction employment rose a still moderate 13,000.

 

Nonetheless, average hourly earnings rose 0.4 percent or 10 cents in June. In the 12 months through June, earnings were up 2.2 percent, the largest increase since July 2011. Tepid wage growth has been holding back the consumer-driven economy.

 

Government employment dropped 7,000 jobs after falling 12,000 in May. Economists, however, say the job losses are likely due to attrition and not the deep government spending cuts known as the sequester; most agencies have relied on furloughs rather than layoffs to achieve savings.

 

Most of the drag came from state government education, although federal government payrolls were also down.

 

The length of the average workweek held steady at 34.5 hours for the third straight month.

 

QE3 Tapering Could Begin in September

 

Could the Federal Reserve begin shrinking the size of its debt purchase program, intended to prop up economic growth and support the labor market, by September of this year? The word on the Street is that economists at the primary banks, those that deal directly with the Fed, believe that to be the case.

 

Economists at Goldman Sachs and J.P. Morgan specifically cited the government's announcement earlier on Friday of stronger-than-expected jobs growth for June as a factor in bringing forward their expected timing of the Fed slowing.

 

According to Reuters, of 17 primary dealers who answered a question on the expected timing of a reduction in purchases, 11 called for September, while three said October, two said December and one said it would happen in the first quarter of 2014.

 

In a similar poll conducted June 19, seven of 17 dealers called for a slowing in September. One dealer in the previous poll had called for the slowing this month, while three said October, one said November while four said December, with one still forecasting the first quarter of 2014.

 

Friday's poll was conducted after the government said employers added 195,000 new jobs to their payrolls last month, and revised its count for April and May to show 70,000 more jobs created than previously reported.

 

The Fed is currently buying $85 billion per month of Treasuries and mortgage-backed securities, and the median of forecasts from 13 dealers in Friday's poll was for buying to initially be scaled back by $20 billion per month. Forecasts ranged from a reduction of $10 billion per month to $28 billion per month.

 

The median forecast for an initial reduction of $20 billion per month was unchanged from the June 19 poll.

 

Of 16 primary dealers who answered a question on the timing of the end of the latest bond purchase program, 14 said it would happen on or before the middle of 2014, while two said September 2014. Those results were little changed from the June 19 poll.

 

The median of forecasts from 13 dealers called for the latest round of quantitative easing, known as QE3, to total $1.3 trillion of purchases of Treasuries and mortgage-backed securities. That was up marginally from a median of $1.255 trillion from 12 dealers polled June 19.

 

Economists at 13 of 14 dealers forecast the Fed will increase interest rates from the current ultra-low level near zero in 2015, while one said it would happen in 2016.

 

Oil Prices Up Sharply

 

Oil prices gained nearly $2 per barrel on Friday, chalking up their largest weekly gain in a year, in no small part because of concerns over rising tensions in Egypt and better-than-expected economic data.

 

Oil prices initially lagged gains but rallied later in the day, extending this week's abrupt gains in spreads on speculation that Midwest oil supplies are poised to tighten. The September versus October West Texas Intermediate spread rose 26 cents to close at a contract high of $1.31 a barrel.

 

With the focus on signs of renewed geopolitical risk in Egypt, crude oil prices extended their string of 14-month highs. Front-month crude oil futures settled $1.98 per barrel higher, or 1.96 percent, at $103.22, after touching a high of $103.32. Trading volume was thin due to the Independence Day holiday.

 

Oil is up 6.7 percent for the week, the largest weekly percentage gain since October 2011. Brent crude oil for August delivery traded at a three-month high and ended $2.18 per barrel higher, or up 2.07 percent, at $107.72 after hitting a high of $107.88. Brent gained more than 5 percent on the week and showed its highest weekly percentage rise since last June.

 

So far, ports and shipping through the Suez Canal have been operating normally, two shipping sources and a canal official said. Other factors are also tightening European oil supplies. Maintenance on the North Sea Forties crude oil field in August will reduce the amount of benchmark oil that underpins the Brent contract.

 

Libya's largest export terminal was shut late on Thursday. Port guards locked the gate over salary complaints, preventing workers from continuing operations.

 

The closely watched spread between global benchmark Brent crude oil and West Texas Intermediate had widened to $5.17 per barrel and settled at $4.50.

 

Brent's premium to WTI crude at one point on Wednesday narrowed to $3.09, the weakest since December 2010, after U.S. government data showed a 10 million barrel drop in stockpiles.