- - Thursday, June 2, 2011

ANALYSIS/OPINION:

Early this week, we left the month of May and dove headfirst into June. While most people saw the Memorial Day weekend as the official kickoff to summer, investors took the view of “two down, one to go” in terms of months in the current quarter.

Unfortunately for most investors, the ups and downs of the S&P 500 during the past two months delivered a return of only 1.5 percent on a net basis, far less than the 2.8 percent the S&P 500 returned in April alone. Keep in mind that those figures reflect month-end data, and returns do not look much better in my opinion when we examine weekly data for the current quarter. I say that because for the four weeks ending May 27, the S&P 500 closed lower each week than the prior week.

Not good. I attribute that balloon leak to the rash of weaker than expected economic data during those weeks, which I touched on in my column last week.

Things have not been much better in June. Granted, we are only a few days into the month, but in those days we have learned that economic growth in China, Australia and other markets has weakened; the domestic manufacturing economy as measured by the Institute for Supply Management’s index and factory orders softened further in April and May; the domestic housing market remains under pressure; and the jobs outlook is looking weaker than previously thought per May data from ADP and Challenger, Gray & Christmas.

European debt concerns increased as well, given Moody’s recent downgrade of Greece’s sovereign debt from “B1” to “Caa1.” The reason? Greece faces a government funding shortfall of $34 billion next year after last year’s $158 billion rescue proved insufficient to resolve the imbalance in the government’s budget.

With all that hitting the market in a few days, the S&P 500 fell from 1,345.20 at the end of May to a low of 1,306 as I write this column. While it appears that the trend of week-over-week declines is poised to continue this week, the degree hinges in my view on Friday’s nonfarm payroll report and the unemployment rate for May.

Following the May ADP employment report, which showed only 38,000 jobs created versus 177,000 in April and 170,000 expected for May, a number of economists have reduced their expectations for last month’s nonfarm payrolls. According to a Reuters poll, economists and analysts now think U.S. nonfarm payrolls increased by 150,000 in May, lower than the 180,000 forecast before the aforementioned May ADP employment report.

To be fair, the ADP report has a poor track record at predicting nonfarm payrolls, but the overwhelming trend in economic activity in recent weeks has been weak. That weakness, coupled with the meaningful increase in input costs year over year (even though oil, gas and other commodities are off their recent price peaks) and an uncertain tax situation as politicians haggle over raising the debt ceiling, make it difficult to argue for a significant upside surprise for the May employment report. That is especially so as weekly unemployment claims reported on Thursday were once again higher than expected and remained well above the 400,000 level for yet another week.

The underlying issue is that while the economy continues to grow, the rate of growth is far slower than what was expected exiting 2010.

What does it mean for the market and investors? In my view, near term, there is more risk to the downside than there is to the upside as company outlooks have yet to catch up with this prolonged soft patch. With a month left in the quarter, it will not be too long before we begin listening for second-quarter earnings pre-announcements from companies. Nokia Corp. already this week reduced its current quarter forecast.

More as it develops.

Chris Versace, the Thematic Investor, is director of research at Think 20/20, an independent equity-research and corporate-access firm in the Washington, D.C., area. He can be reached at cversace@washingtontimes.com. At the time of publication, Mr. Versace had no positions in companies mentioned; however, positions can change.