Friday's jobs data looms as the first major economic report of the year's second half, which promises to challenge markets with slower economic growth.
However, even if that June employment report disappoints and other June data is weak, strategists say mid-July corporate earnings season could provide the spark for a brief rally in stocks.
"I really think we could have a rally in the summer during earnings, followed by a pullback," said Stuart Freeman of Wells Fargo Advisers. "I do think it's going to be difficult to have earnings beat expectations 77 percent of the time like we had in the first quarter. That was pretty exceptional, but they may be in line to be somewhat better than expected in the quarter."
Barclays Capital's Barry Knapp, who heads U.S. portfolio strategy, agrees the earnings period could provide a springboard for stocks, especially since the market has sold off ahead of the earnings. In the past couple of quarters, stocks moved higher ahead of the earnings season, and then sold off as the reports were released.
Freeman said European weakness and the stronger dollar could affect earnings, but overall he expects earnings to be strong and margins high as companies continue to hold back on hiring. Operating margins in the last quarter were 8.2 percent for the S&P 500, up from a more than 20-year average of 6.7 percent. Consumer discretionary companies, for instance, saw margins of 5.5 percent, compared to their normal 3.8 percent level.
"I think we will continue to have good, solid earnings this year, but I don't think they're going to be driven heavily by revenues. So far, we're five percent off the bottom in terms of revenues for the S and P...Earnings were 59 percent form the bottom of the trough, which was a year ago," Freeman said. Margins should stop expanding and return to more normal levels. "I think the market will be happier to see more revenue growth and less margin growth anyway," he said.
Stocks just came off one of the worst weeks of the year, with the Dow down 306 points, or 2.9 percent to 10,143. The S&P 500 fell 40 points, or 3.6 percent to 1076. The energy sector was the worst performing of the major Standard and Poor's sectors, down nearly 6 percent. Financials, which rallied nearly 3 percent Friday, were best performing sector, with a 1.4 percent loss.
For the second quarter, the Dow is down 6.6 percent and the S&P fell 7.9 percent. It's no surprise that gold stocks were among the best performers, gaining nearly 15 percent and oil services at the bottom, down 15 percent.
What to Watch
The jobs report is by far the most important data point of the coming week, but there is personal income on Monday; S&P/Case Shiller Home price data Tuesday: ADP payroll and Chicago purchasing mangers data Wednesday, and the ISM manufacturing survey Thursday. Weekly jobless claims, auto sales and pending home sales are also reported Thursday.
The continuing gusher of oil spewing into the Gulf of Mexico from BP's broken well continues to unnerve investors. In the coming week, the situation could be complicated if a tropical depression in the Western Caribbean turns into a major storm for the Gulf. Oil prices hit a seven-week high on concerns about he storm disrupting oil production. Oil rose 3 percent to $78.86 per barrel Friday.
Investors will also continue to study the implications of the combined financial regulatory reform bill, which should come to the House and Senate for votes in the week ahead. Keefe Bruyette analyst Brian Gardner said that the bill is not as bad for banks as had been feared, and the industry actually had some gains in it.
"I think the derivatives legislation is generally a negative for the banks by the construct that's in the bill of moving a lot of the derivatives business onto clearing houses and mandating exchange trading, which are laudable policy goals. I think Washington is shifting that part of the business away from the banks, away from new York and to Chicago, the CME and other exchanges," Gardner said on "Squawk on the Street" Friday.
There will also be weekend news from the G-20, meeting in Toronto.
There are also several earnings reports in the coming week, including Micron on Monday; General Mills on Tuesday; Monsanto and Apollo Group on Wednesday, and Constellation Brands on Thursday.
It's the Economy, Stupid
Treasurys in the past week saw prices rise and yields decline, as weak economic news drew in buyers. The 10-year yield fell to 3.119 percent, and was close to 3 percent on an intraday basis during the week.
Pimco strategist Tony Crescenzi said much of the market's activity ahead of the quarter end on Wednesday has been completed.
He also said if the Friday jobs report disappoints, the 10-year could see a yield of 3 percent or lower. "For the 10-year to fall meaningfully below 3 percent and stay there, we would have to see signs that Europe's woes affected confidence," said Crescenzi. He said the jobs report will be a window into whether the European debt crisis is effecting CEO confidence and making companies more cautious.
"All eyes will be on what the June jobs numbers look like coming into next week, and then we have earnings season. Either we're going to get confirmation that things reversed a bit or May was a bump in the road in a slow recovery," said Art Hogan, managing director at Jefferies and Co. "(Non-farm payroll) estimates have gone from minus 50,000 to minus 110,000 for the headline number."
The June data, like other months this year, was affected by the temporary employment of government census workers, which added to May payrolls. For June, the number is expected to be a negative. Hogan said private payrolls are expected to be 113,000, an estimate that has been rising. "We're at minus 125,000 and we're factoring in a loss of 170,000 on the census," he said.
Mark Zandi, chief economist with Moody's Economy.com, said he's looking for a loss of 100,000 to 150,000 payrolls for June, including the loss of 250,000 temporary census workers. He expects the unemployment rate to rise to 9.8 percent from 9.7 percent in May.
"The economy lost a lot of momentum at the end of q1, and it looks like q2 is going to be at best 3 percent, so the economy is turning soft. I think that we will make our way through without stepping back into recession. The odds are still well below one in four that we double dip," said Zandi.
However, if Congress does not extend state aid and unemployment benefits, the odds of re-entering recession rise to one in three, he said. Those programs were included in the jobs bill that failed to pass the Senate Thursday.
"That will get resubmitted. I think they're going to get more weak economic data which is going to be fairly scary. So the odds are they will pass it. The housing market is double dipping. that's not surprising," said Zandi. "...When house prices are weakening, nothing really works that well in the economy, and the European debt crisis doesn't seem to go away. Whatever European policy makers do, it seems to continue on and that hurts the stock market and that hits consumer spending."
State and local governments are going to start cutting more aggressively. We're going to see more tax increases and more spending cuts. On top of that, the inventory swing is pretty much played out. The second half of the year is lining up to be on the soft side," he said.
Economists were surprised Friday when the government revised down first quarter GDP to 2.7 percent from 3 percent. Housing data was also surprisingly week and new home sales were at a record low.
"I had 2.5 pct second half growth for a lot of these reasons but I'm much more nervous," he said.
Freeman said news like the GDP revision is one reason the market will stay "stressed."
"A lot of times, coming out of a regular cycle that number would have been 5 or 6 percent. It would typically be above the average rate of 3 percent. This has been the slowest, worst recession of the average of the last 10, and the worst recovery of the average of the last 10 in terms of strength because it's such weak growth," he said. "Every little thing that slips a long the way is going to cause a disturbance. We'll have some good news. We'll have set back news."
He expects the S&P 500 to end the year close to where it is now—1100 to 1140—and it could trade above that level and below current levels between now and then. The lack of jobs is one of the biggest problems that has to be solved.
"Part of the problem we have now is ... so much policy change going on. Everyone knows taxes are going up, but they don't know how, and the they all know health care is changing and they don't know how it's changing their businesses. You have a lot of companies standing there like deer in headlights. It's affecting decisions," he said.
Zandi said the second half will feel softer than the first half.
"It's going to be very uncomfortable. All the double-dippers will be out in full force," he said.
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