Wall Street Is Still Operating on Hope

by: James Picerno

The momentum in the front line of the recession still favors the dark forces of contraction, today's update on employment for April suggests. One can argue that there's a bright side to the job destruction, but that's still wishful thinking. Indeed, it's hard to put a positive spin on a retreat of 539,000 for nonfarm payrolls last month.

Yes, that's better than the 699,000 drop in March, but then that's not saying much. The hope is that the slowing pace of job loss is a sign of better times. Perhaps, although we shouldn't expect too much too soon. The vanishing act in jobs continues to be widespread and deep, affecting both the goods-producing sectors as well the services side of the economy.

Still, the worst of the labor market's contraction may be behind us, which is a reasonable forecast, as the apparent topping out in new filings for jobless benefits suggests. Yesterday's update on weekly claims for unemployment benefits implies no less. But a slowing rate of job loss isn't the same thing as job growth. Even if the labor market contracts at a much slower rate of, say, 200,000 jobs a month for the rest of the year, that's still another 1.6 million fewer workers earning a paycheck by New Year's Eve.

Meanwhile, in the here and now, the labor retreat in this recession is already much deeper than any downturn in a generation, according to the Economic Policy Institute. And more losses are likely in the months ahead. But let's assume no more labor contraction. We're still facing quite a challenge in rebuilding. Just to return to the pre-recession labor market status, the economy at this point needs to create 7 million new jobs, according to EPI. That's a daunting number if you consider that nonfarm payrolls grew by 7.9 million in the 5 years through the end of 2007. But that was a period of robust growth, cheap money, a roaring bull market in all the major asset classes, and a real estate boom of unprecedented proportions. Don't hold your breath for a repeat any time soon. The reason is debt. There's lots of it, and it weighs especially heavy on household balance sheets.

The oft-cited statistic that consumer spending accounts for 70% of GDP is relevant here—painfully so. Indeed, it's going to take time for Joe Sixpack to work through the twin challenges of falling house prices and the growing odds that our hero will be out of work for some time.

Meanwhile, as if all this wasn't tough enough, there's a new threat afoot in the rising yield on the benchmark 10-year Treasury Note. Yesterday, the 10-year closed at roughly 3.3%. That's up sharply from the ~2.5% level reached right after the Fed's announcement on March 18 that it would directly buy long Treasuries in an effort to keep rates low. The question here is whether the Fed's losing control of its ability to keep the price of money low. Eventually, the market will have its way, which is to say that rates will rise. The hope has been that Bernanke and company would be able to keep market forces at bay long enough to allow growth to take root. At the moment, there are renewed concerns about the viability of this plan.

All of this raises questions as to whether the recent stock market rally has gotten ahead of itself. Ed Yardeni of Yardeni Research, in a note to clients this week, advises that while U.S. stocks have rallied sharply since mid-March, forward earnings for the S&P 500 have dropped. The expectation seems to be that earnings in the coming quarters will bounce substantially higher and validate the higher equity prices.

Hope, it seems, remains the main support system behind the renewed optimism on Wall Street, or what's left of it. But hope only gets you so far. Soon, and perhaps sooner than the crowd thinks, hard numbers showing recovery will be required to keep a fresh round of selling from returning. Otherwise…

For what it's worth, we're not yet confident that the old market lows won't be tested anew.