Financial Markets Continue To Rise Despite Dismal Employment Data

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Summary

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Source: Philadelphia Inquirer

The coronavirus has led to entire businesses being shut down and millions of Americans stuck at home. This has also caused unemployment to spike. The April jobs report showed the economy shed 20.5 million jobs:

US unemployment has surged to 14.7 per cent, its highest level since the second world war, as the coronavirus pandemic led 20.5m Americans to lose their jobs in April in a painful blow to the world's largest economy. The grim picture of the US labour market in the midst of lockdowns and restrictions that have choked off economic activity will heighten concerns that any rebound from the suddenly deep recession could take longer than expected just a few weeks ago. It will also raise pressure on US government authorities, from the White House to Congress and the Federal Reserve, to consider larger and more lasting stimulus measures to support the economy.

The previous thesis held that President Trump must grow jobs in order to ensure reelection. The current jobs picture could prompt more stimulus effort from Congress, the president or the Federal Reserve. This was the largest drop in jobs on record, yet it was still better than the 21.7 million expected by economists.

Leisure and hospitality jobs fell by 7.7 million or 47 percent. The lion's share of the decline occurred in food services and drinking places. This made sense, given that restaurants and bars have been closed throughout the country to help stem the spread of the pandemic. Employment for the arts, entertainment and recreation industry and the accommodation industry fell by 1.3 million and 839 thousand, respectively. The government wants to quell large gatherings, which could create major headwinds for arts and entertainment even after the economy reopens.

Education and healthcare services experienced a 2.5 million fall-off in employment. Offices for dentists, physicians and other healthcare practitioners were closed, creating sizable job losses. Jobs for professional services and the retail trade fell by 2.2 million and 2.1 million, respectively. Several traditional retailers closed stores temporarily in March. They are reopening stores on a market-by-market basis, yet retail sales could be in doldrums for a while.

Unemployment Rises To 14.7 Percent

The unemployment rate during the month was 14.7 percent, up from 4.4 percent in March; April's unemployment rate hit a post-war record. In previous years, the unemployment rate was much lower than the 5.0 percent threshold considered full employment. Such low rates suggested a white hot economy at risk of overheating. That is no longer the case. Policymakers now want to ignite growth to keep the economy from spiraling into a potential depression.

Over 2 million more people applied for first time jobless claims last week. However, such claims have slowed for eight consecutive weeks. They could slow further as states begin to slowly reopen, employees return to work and the economy starts moving again. I believe we were already at peak economy prior to the pandemic. Consumer spending had held up the economy for several quarters; I doubt consumers will spend at the same levels as they had in the past. That does not bode well for the economy over the long term and suggests the unemployment rate may not return to previous lows.

The unemployment rate also does not capture employment age individuals no longer looking for work. The labor participation rate was 60.2 percent in April, down from 62.8 percent in the year earlier period. The labor participation rate has not been consistently at or below 63.0 percent since the Carter administration - a period characterized by economic quagmire. There were 103.4 million Americans not in the labor force, up from 96.1 million in the year earlier period. This should improve as the economy continues to reopen, but will it improve enough for the American people to give President Trump a second term?

What Is Next For Financial Markets

During the Financial Crisis of 2008/2009 Federal Reserve Chairman Ben Bernanke worked closely with President Obama to help guide the country through one of the worst financial crises in my lifetime. Current Fed Chairman Jerome Powell is again working closely with policymakers to keep the economy from the brink of depression. The Fed has been providing liquidity to the bond market to ensure credit continues to flow. In April, the Fed announced a $2.3 trillion relief package for small businesses and local governments. Jerome Powell recently voiced a willingness to provide more stimulus measures if needed:

He did signal that the White House and Congress should be considering additional fiscal stimulus, on top of the $3tn already passed since the start of the crisis. Democratic lawmakers in the House of Representatives this week unveiled legislation for a further $3tn in stimulus, though Republicans panned the proposal, heralding tricky negotiations. "Additional fiscal support could be costly, but worth it if it helps avoid long-term economic damage and leaves us with a stronger recovery. This trade-off is one for our elected representatives, who wield powers of taxation and spending," Mr Powell said.

A lot has changed since the pandemic hit. Brent oil fell below $10 in late April. However, supply cuts from Russia, Saudi Arabia and certain U.S. drillers helped stabilize markets. Brent oil is now above $30 and could rise further once the economy continues to reopen. Rising oil prices should help stabilize jobs within the oil sector and help oil-related names better service debt.

The combination of monetary stimulus and rising oil prices has also helped stabilize financial markets. The Dow Jones (NYSEARCA:DIA) is down by double digits YTD, yet up over 35 percent from its 52-week low achieved March. Monetary stimulus and chatter of Fed support caused animal spirits to return to financial markets. Fundamental analysis may have been thrown out the window for now. Stocks will likely rise on sentiment and weekly news of companies reopening, while remaining mindful of social distancing measures and precautions to protect employees.

Q1 GDP fell 5.0 percent, with personal consumption expenditures falling 6.8 percent and business fixed investment down 8.7 percent. If consumer spending does not return to previous levels, then GDP growth could remain negative for the rest of the years. That said, two sectors of the stock market that could be vulnerable are retail and travel. Consumers may not consider apparel and commercial travel as essential items going forward. Investors may want to avoid these sectors even if broader markets continue to rally.

Conclusion

Financial markets should continue to rally as the economy reopens in phases. Investors should also avoid cyclical names and highly-indebted names that need consistent cash flow to service debt.

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