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Week Ahead: Focus on US Economy as Europe Keeps Markets on Edge

Wall Street may finally shift its focus back to the U.S. economy, after weeks of zeroing in on problems in the euro zone.

European headlines will continue to sway nervous markets in the coming week. But the heavy schedule of U.S. economic news crunched into the four-day post Memorial Day week should paint a good picture of the state of the economic recovery and the financial mood of U.S. consumers.

Euro bills and coins
AP
Euro bills and coins

The big report of the week is Friday's May employment report, which could be a game-changer for markets. Economists are looking for signs the economy continued to create jobs beyond the 300,000 plus temporary government census workers that are expected to show up in the jobs data. The May employment report is expected to show the private sector created somewhere between 150,000 and 250,000 non farm payrolls.

There is also ISM manufacturing data, car sales and chain stores' monthly sales reports.

"Generally speaking, the data should be okay in the next week, but for the past few weeks it hasn't mattered," said Miller Tabak chief economic strategist Dan Greenhaus.

Markets Mayhem

Stocks ended a volatile May on a sour note, reacting Friday to news that Fitch downgraded Spain after European markets closed. The Dow lost 7.9 percent to 10,136, its worse May performance since 1940. The S&P 500, at 1089, was down 8.2 percent for the month but was fractionally higher for the week. Year-to-date, the S&P is down 2.3 percent, and it is still up 61 percent from its March, 2009 low.

Gold gained 2.7 percent in May, to $1212.20 per ounce, as fearful investors clung to the metal but dumped other commodities. Oil lost nearly 12 percent in the monthto $73.97 per barrel. The dollar gained 2.5 percent against the euro, which was at $1.2270 Friday. The bond market has been the winner as investors fled to the safety of U.S. Treasurys in May. The 10-year finished the month with a yield of 3.3 percent.

"I do think there are oversold conditions, not only in the U.S., but globally. I think it's the expectations that we're going to go back into a double dip. We're not going back into a global recession. We do see some bear markets in emerging markets, and 10 percent plus losses in some developed markets, but they may be unwarranted. They're getting overdone," said Joseph Quinlan, chief market strategist for U.S. Trust.

As for the U.S. markets, "We're relatively speaking very attractive. It's going to be earnings and employment that help drive the U.S. economy and attract capital not only off the sidelines in the U.S. but from overseas," he said.

"The companies are kind of putting their money where their mouth is...The earnings are good. I do expect to see continued job growth. I think the (private sector) number should come in around 250,000 and that's a good healthy number," said Quinlan. "We still have some work to do on the job front...from talking to companies large and small, they are hiring...whether it's Wall Street, Chicago or Texas."

"If you get a good robust jobs number, that will allow the U.S. to de-couple a little bit from the Europe problems," he said.

Quinlan said his sector focus still favors information technology, materials and energy. He said he is staying away from financials because he is concerned by uncoordinated reform of the industry globally.

"I think energy is the outlier. I think this is a very good time for investors without exposure to energy to get some," he said. He noted that the drop in oil prices, even with the curbs on off shore drilling, could ironically make alternative fuels less in demand and keep the reliance on oil.

Energy stocks were the worst performers in May, down 11.8 percent. British Petroleum , which is trying to cap the flow of oil in the Gulf of Mexico, lost 17.7 percent in the month. Transocean lost 21.5 percent in May, and Halliburton lost 19 percent.

Economists' Jobs Forecast

Econorama

The consensus of economists is that 563,000 non-farm payrolls were added in May.

Goldman Sachs economist Andrew Tilton said he expects to see a payroll number of 500,000. He expects 150,000 of that number to be private sector jobs. Last month, payrolls totaled 290,000 and the unemployment rate was 9.9. Tilton expects to see the unemployment rate drop to 9.7 percent.

"I would say jobs is the most important data, particularly private sector job growth," in the coming week, he said. "It doesn't have to be better than last time, but people are certainly expecting a three-digit gain."

Pierpont Securities chief economist Stephen Stanley said he expects to see about 230,000 new private sector jobs for May, up from 200,000 in April. He expects the overall number to be 640,000. The number of census workers should peak in May and turn negative in July and August.

Other data due in the coming week includes ISM manufacturing and ISM nonmanufacturing data, reported Tuesday and Thursday respectively. Those reports are also watched for clues about hiring trends in those sectors of the economy. ADP's employment report, released Wednesday is also a kind of early look at May's hiring activity. Weekly jobless claims are reported Thursday.

"The ISM manufacturing index, which is a pretty good bellwether for industrial activity, arguably may have peaked, so we may be seeing a little deceleration. That seems to be the message we're getting from some of the surveys we've seen this month, but it's still solid growth," said Tilton. He sees ISM slipping to 59 from 60.4 last month.

"The other thing that is important is we'll have the initial same store sales results for May (Thursday), which I think are widely thought to be a little softer, but obviously people will be interested in the details, along with auto sales (Wednesday). Those will give you a sense of how strong consumption was in May," he said. "We had a real consumer spending number for April which, was flat after a couple months of gains."

Tilton said a slowing in consumer activity would be consistent with Goldman's expectation of a softer second half. The firm's GDP forecast for the second half is currently 1.5 percent, down from 3 percent in the first half.

Other data due in the coming week includes construction spending, reported Tuesday; pending homes sales Wednesday and factory orders Thursday. Productivity and costs are also released Thursday.

Economists have been watching the unfolding of events in Europe, wary that its problems could be carried by the banking system to the U.S. Tilton said so far the economic impact would be modest.

"It's really credit that separates the mild or moderate scenarios from more severe scenarios," said Tilton in an interview Friday morning. "Market moves have definitely been more constructive in the last couple of days. You have seen some improvement in some credit spreads. They're still at quite elevated levels relative to a month ago, but at least incrementally on the week, they're a little better."

"The bottom line is there are some signs, if not easing, of at least stabilizing of some of the credit stresses. That is key because if banks continue to see higher funding costs and decide to pull back on the marginal loan or investment that ultimately represents tightening of financial conditions and that's bad for growth," he said.

Stanley said he does not expect the U.S. economy to take a serious hit from the European sovereign problem, despite its impact on markets this month. "The only way this really bleeds into the U.S. economy significantly is if the markets seize up again...I don't see that happening. People are reassessing the credit worthiness of European banks and I think that's a fair thing to do," he said.

What's an Investor to Do?

Euro Trashed

The Friday afternoon downgrade of Spain by one notch sparked the week's final round of euro-related selling of stocks and other risk assets. Lord Abbett chief fixed income strategist Zane Brown said Moody's should follow shortly with a downgrade of its own.

"It's not totally unexpected and it's certainly justified, and it probably increased Fitch's focus when the vote on the austerity plan was so tight. It only passed by one vote. You had what was a credit and liquidity crisis in Europe, now translating into a growth problem," said Brown.

"I think you saw such a big reaction (to the Fitch news) because the amount of claims outstanding for Spain dwarfs any of the other countries that are a problem. When you look at the Bank of International Settlements publications for Spain, at the end of 2009, the total outstanding claims was for $1.45 trillion, compared to $236 billion for Greece, a factor of five. This headline really resonates with many more people and it really resonates with euro zone banks," said Brown.

What to Do?!

Economists and market strategists expect Europe's woes to take a very long time to heal, and they have differing views on the outcome. Brown, for one, believes the euro zone will ultimately be disbanded with the southern countries going off on their own, and the stronger northern economies sticking together on the single currency.

George Magnus, senior economic adviser to UBS Investment Bank in London, said he believes euro zone leaders need to make a more forceful stand to rebuild credibility in their effort and the crisis will continue at a more heightened pitch than necessary until they do.

"In the immediate future, this year, or as soon as possible, I think they have to take control of a very unstable situation and try to demonstrate in a series of confidence building moves that they are able to take charge of the situation," Magnus said. "..The markets don't believe that the banks are safe, and that is the most immediate problem."

"The leaders haven't shown a willingness to act in the right way," he said. "It's not a problem of liquidity in the system. There's about 800 billion worth of euros sloshing around which is funding a very big portion of the banks' balance sheets. We have the liquidity and if the European leaders could ever come together and put their money where their mouth is and put on loan guarantees...If they could actually spring on us one weekend an orderly debt restructuring of of Greece, and as far as they could anticipate recognizing losses creditors would have to take," he said.

Magnus said at the same time, the European banks need to increase capital levels. "My idea really is to take a leaf out of Brady bonds in 1989.. That only happened after the Latin American debt crisis had already permeated the region... it wasn't exactly early days in terms of the crisis, but we can't wait six years. The principal behind the Brady bonds was both borrowers and creditors had an incentive to get involved...they would only be eligible to participate in the scheme if they were committed to financial reforms as well, and most of them did," he said.

On the lender side, banks would have to face reform that would improve capital levels. The topic is expected to be discussed in Toronto by G-20 leaders at the end of June, and it will be discussed by Treasury Secretary Timothy Geithner and other finance ministers at a meeting in Korea later this week.

"The kind of bottom line issues about how global banks will be expected to behave and be monitored, I think they want to button that up and kick it along in June so that by November there actually is an agreement," he said.

Questions? Comments? Email us at marketinsider@cnbc.com

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

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