Recession Talk Resumes
Stock market bulls got their weak jobs report -- and then some.
Shares tanked Friday after the government reported that private payrolls contracted in August, marking the first monthly nonfarm job loss in four years. Bond prices rose as investors bet the unexpected decline in employment will finally force the Federal Reserve to cut its fed funds overnight lending target, which has been stuck at 5.25% for more than a year. The dollar dropped and gold prices surged.
"If there was any doubt over whether the Fed would be cutting interest rates on Sept. 18, this report should remove it," writes Nigel Gault, chief U.S. economist at Global Insight.
The report hammers home the widely held suspicion that this summer's credit crunch has started to bleed into the economy's performance. Some bulls on stocks had been eagerly awaiting a bad economic number, on the thesis that a Fed easing will get the economy running again and boost share prices.But August's loss of 4,000 jobs, in a month when economists were predicting a gain of more than 100,000 positions, failed to lift the stock market Friday, because it raises -- in some minds, at least -- the prospect of a recession. The Federal Reserve lives and dies by the unemployment report. Fed economists reason that tight labor markets stoke inflation by driving up wages, which leads companies to raise prices. With weakness in labor, the Fed can stimulate the economy with an easy conscience. Gault predicts the Fed will cut three times by year-end. He says that in light of the weak jobs report, the question is "whether the Fed should be more aggressive and cut by 50 basis points at its next meeting." That's not the only question, though. Even with financial stocks like Countrywide (CFC) and Bear Stearns (BSC) taking a beating day after day, some observers continue to doubt that the economy is actually in such dire straits. The Economic Cycle Research Institute, for instance, is sticking to its no-recession call despite another consecutive plunge in its weekly leading index of economic growth. The index shows growth in the week fell to a rate of 0.6%, approaching contraction territory after a precipitous decline from 5.1% at the start of August. "In theory, if the jobs numbers continue to be negative, and production, sales and income are all negative starting now, in theory a recession can begin now, but for all of those things to occur is highly unlikely," says Lakshman Achuthan, managing director at the institute. "Sales, production, and income figures are much more buoyant, and this jobs number is more of the exception than the rule." Just a day ago, the stock market gained ground on stronger-than expected reports on productivity, and back-to-school retail sales. Wednesday, the Federal Reserve's report from various districts around the country showed economic expansion outside of housing and auto industries. FTN Financial's equity market strategist Tony Dwyer believes Friday's payroll report is not a recession red flag. "The bullish thesis is exactly what is happening," he writes in a note to clients, adding that the market is likely to retest its August lows before lifting again. "Slower than expected growth on the back of the consumer that removes inflationary pressures allowing interest rates to stay low, EPS [earnings per share] to grow moderately and valuations to expand as the Fed lowers rates to stimulate future growth." Dwyer believes this environment matches more closely with 1995, when jobs fell by 9,000 in April and 101,000 in May. The economy avoided recession then because business spending remained positive, if slower. If the economy can sidestep recession, buying stocks may be an easy call to make. Going back to 1960, in periods when the Fed is cutting the fed funds rate, the S&P 500 has risen in the first month following of the easing cycle 10 out of 11 cycles, according to Bespoke Investment Group. In June of 1989, the Fed embarked on its longest easing cycle, which lasted 40 months and brought the fed funds rate to 3% from 9.75%. In that cycle's first month, the S&P 500 declined 0.9%. Over the whole 40 months, it gained 29.5%. By contrast, in 1987, when the Fed eased after the October stock market crash, the S&P 500 gained 9.75% in that first month of rate cuts. Over the whole cycle, it added 14.15%. In the last cycle, which began in January 2001, the S&P 500 added 1.92% in the first month, but declined 27.62% over the whole 30 month period of Fed easing. In such a slow growth environment, Dwyer recommends buying technology and health care sectors. He recommends selling materials and energy stocks on the assumption that global economic growth will also slow. Indeed, as the U.S. likely embarks on slicing rates, the tightening campaigns of many foreign central banks are hitting a wall. In recent weeks, the European Central Bank, the Bank of England and the Bank of Japan have all held steady on their overnight borrowing rates.
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