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Stocks Could Follow Employment This Summer

If there is little change in employment levels this summer, stocks may go nowhere. If there is any negative news about employment, the market is especially sensitive and could react badly.

NEW YORK (TheStreet) -- Stock markets cheered a 225,000 drop in continuing unemployment claims this week. Those cheers are misplaced.

When I wrote about

unemployment claims in January, the conclusion was that WIUC (Weekly Initial Unemployment Claims) were on the trajectory expected for a solid recovery when compared to past economic cycles. That conclusion is no longer supported by the more recent data. The title of the review in January was

Weekly Unemployment Claims Are Behaving Well.

Unfortunately, the current article has exactly the opposite theme. This title might well have been

Unemployment Claims Are Not Behaving Well.

The following graph updates the WIUC history first presented in the January article.

Business cycles of the past 50 years can be divided into broad initial unemployment claims peaks (1970, 1991 and 2002) and sharp peaks (1975, 1980, 1982 and 2009). This graph points out a feature not discussed in January: Each of the sharp peaks has an associated consolidation area in recovery (red circles). This gives us an additional data set to compare business cycles. Characteristics of the four consolidations are compared in the next graph.

The consolidation in the decline from the current sharp WIUC peak is taking much longer than for the other three. It is already 50% longer than the next longest in 1983 and double the length of the other two. It will take a major change in the trends of the past six months for the current consolidation to end soon, so this recovery appears to be strongly diverging from the pattern of the other three comparable recessions. This is seen in the update of a graph from the January article.

After 42 weeks (January article) there were clearly two groups: fast decliners, with four members and slow decliners, with three. Now, with 61 weeks into recovery from the peaks in claims, there are exceptions. The current curve has slowed from the fast decline trajectory and the 1990 curve has moved into a trend parallel to the fast declines.

Continuing Unemployment Claims

The headline Thursday morning trumpeted the "huge" drop in continuing state unemployment claims. This drop (225,000) is indeed double the three previous weekly declines this year.

The size of the drop this week follows the second largest increase of the year the prior week and the four-week moving average is only slightly changed. Of course, this could be the start of a more rapid down trend. However, it is more likely that this is just a data fluctuation within the 2010 trend of very slowly declining continuing state unemployment claims.

The story is different for the extended federal benefits which show a more significant drop in the past two months. The decline of 900,000 is nearly 80% greater than the 515,000 jobs added to the employment ranks in the same period. Many of these jobs could have come from sources other than those whose federal benefits expired, so the decline in federal benefits likely represents a new wave of financial distress for individuals.

Impact on Investors

The dramatic advance of stocks in 2009 was discounting an economic recovery. Prices have built in the expectation of a continuing improvement in employment numbers for the second half of 2010 and beyond. The surprisingly poor

May employment numbers reported here last week have raised doubts about that improvement. In spite of the continuing unemployment claims news this morning, the claims data is also raising doubts about how employment will trend in the coming months.

If employment improvement stalls, stocks will most likely remain stalled as well. A trading range could well ensue for the coming months if the number of employed remains in the current range (138.3 million to 139.5 million for 2010). The trading range I have identified for my clients for 2010 has the


trading between 9,500 and 11,500 for the rest of 2010. In a shorter time frame (then next six weeks) I am looking for a trading range on the

S&P 500

between 1050 and 1130. Closes below 1050 would have me consider lowering my trading range outlook. Closes above 1130 would cause me to reevaluate the upper range limit projection.

With the uncertainty in the market, it seems reasonable to review positions held for more than a year. Some capital gains should be booked for many investors who have significant gains from the 2009 rally. Holding significant positions in indices is not what I am recommending now. Trading opportunities will exist for index ETFs such as DIA, SPY and QQQQ. The more aggressive may trade leveraged ETFs, such as SSO (2x S&P 500) and QLD (2x Nasdaq 100) or SDS (2x short S&P 500) and QID (2x short Nasdaq 100).

It's time for investors to be on their toes. Stocks could well follow employment this summer. If there is little change in employment levels this summer, stocks may go nowhere. If there is any negative news about employment, the market is especially sensitive and could react badly.

Author is long several S&P 500 stocks. No trading positions in ETFs at the present time.

John B. Lounsbury is a financial planner and investment adviser, providing comprehensive financial planning and investment advisory services to a select group of families on a fee-only basis. He worked for 34 years with IBM, and spent 25 years in R&D management and corporate staff positions. He also was a Series 6, 7, 63 licensed representative with a major insurance company brokerage for nine years.

Specific interests include political and economic history and investment strategy analysis. He holds degrees from the University of Vermont, Columbia University and the Illinois Institute of Technology, where he studied chemistry, physics and mathematics. He is a contributor to Seeking Alpha and his own blog,