Daily Insight

As everyone knows by now stocks took a hit on Friday following the Labor Department’s release of the May job-market figures and oil’s record one-day rise of $10.75 per barrel, or 8.41%.

It was really that jump in crude prices that pushed the market down 394 points – on the Dow average. The three major indices were lower by roughly 1.5% around lunchtime, but as oil got on its horse and rocketed up to nearly $140 in the afternoon session stocks doubled their morning-session losses.

As an aside, the price for a barrel of oil prior to the 9/11 attacks and aggressive Fed easing that ensued was only $11 more than the change of the past two trading sessions – crude has risen $16.24 since Wednesday’s close. The price of barrel of crude was $27.63 on September 10, 2001.
But it wasn’t only oil that pushed stocks lower, a jump in the jobless rate stunned traders, who sent the indices lower in the morning session. We’ll get to the specifics of that jobs report below.

On Tuesday we mentioned that a 134-point move on the Dow was nothing, those comments followed Monday’s media response which acted as if this is a big deal. With the Dow above the 12,000 mark, that level of decline is nothing and we wrote that one should be prepared for 3% down days in this market, which is what we got on Friday.

It was just an ugly day as all 10 major S&P 500 industry groups declined. Financial, industrial, information technology and consumer discretionary stocks led the move lower. While there are a number of uncertainties equity investors are burdened with at the moment – as we’ve touched on many times (the election, and thus tax and trade policy; the housing correction, geopolitical events, sky-high oil) the one thing many people aren’t talking about is the boost stocks would get from a large decline in oil prices.

It seems difficult to comprehend right now, but with crude up this big, it means there is a long way for the price to fall and still factor in geopolitical risks and a domestic energy policy that is removed from reality.

What was behind oil’s climb on Friday? Well, first it was another day of dollar decline as the employment report pushed the greenback lower. This move caused traders to increase their position in oil.

Then word came out that Israel is looking to strike Iran as they continue to restrict weapons inspections while stating Israel “is about to die and will soon be erased from the geographical scene.” This prompted a number of Israeli officials to state they will go after Iran’s nuclear program as the threat becomes too pronounced. Prime Minister Olmert also stated he’d had enough of Hamas lobbing bombs out of Gaza and time has come to do something about it. Comments like these cause anyone with a short positions to ask whether they want to go into the weekend with this trade, and hence the additional rally in the afternoon took place.

We were looking so good too. The dollar had gained nice ground after Bernanke’s much desired comments had given a boost to the greenback and sent oil lower earlier in the week. But ECB president Trichet stabbed the Fedhead in the back on Thursday – as we touched on in Friday’s letter – and then the job market data and Israel/Iran thing reversed all of that.

OK, let’s get to the job report, which was the major news of the day before oil’s meteoric rise.

The stunner was the jump in the unemployment rate, rising to 5.5% from April’s 5.0% reading. This marked the largest monthly rise in the jobless rate since February 1986. The major reason for the move was not a meaningful decline in jobs, but a huge rise in job market entry of 577,000 participants.

The net job losses for May actually came in lower-than-expected as we lost 49,000 payroll jobs – the market was expecting a decline of 60,000. Either one of these figures is statistically insignificant for a labor force of 138 million and doesn’t even come close to explaining the ½ percentage-point rise in the unemployment rate. Rather, it was a huge rise in 16-19 year olds entering the labor force that sent the rate higher – this segment accounted for 66% of new entries and since it occurred in May, when June is typically the month in which we see students enter, it created havoc in seasonally adjusting the figure.

I’m not trying to say that net job losses are a good thing, it’s clearly a bad situation whenever this occurs. But what led the unemployment rate higher needs to be explained and the reasons for the move higher suggest to me that we’ll see the rate hold there in the following months or actually decline due to the seasonal adjustment as student entry will be lower than is normally the case for June. The unemployment rate for teens jumped to 18.7% from 15.4% in April.

Also, think about it. If we’re going to be in a period of job-market weakness, trust me, this is what you want to see. There have been a net 324,000 jobs lost during the past five months, that’s can be one month’s worth of declines during the typical period of significant job-market weakness. We’ve only lost 4% of the 8 million positions created in the 4 ½ years prior to this five-month down trend. While the change is often more important that the level, one finds it difficult to become too concerned over a 5.5% jobless rate – which is below the 30-year average of 6.07% and right on top of the 20-year average of 5.42%.

The job losses came from construction (-34,000), manufacturing (-26,000) and business services (-39,000). The largest increases, which has been the trend for several months, came from health-care (+42,000) and education (+12,000). The public sector added 17,000 jobs.

In a separate report, the Commerce Department reported that wholesale inventories jumped 1.3% and sales rose a strong 1.4%. This data is for April and fairly outdated, but it does suggest that inventory re-building will help boost second-quarter GDP – assuming we don’t get declines in May and June. The 1.4% rise in sales means the inventory-to-sales ratio has moved to an all-time low of 1.09 months’ worth of supply. Production will catalyze growth in the months ahead and lead to higher GDP readings in the third and fourth quarters.

Some, the typical economists that we hear from month after month, attempted to say that the rise in sales came only from petroleum activity. But the wholesale business sales ex-petro rose 1.5%, so the negative spin hardly adds up.

For an economy that is supposed to be so down and out, a number of data points are just not showing it, including the business and wholesale sales data.

Have a great day!

Brent Vondera, Senior Analyst