Stocks Slammed on Dismal Jobs Report

The unexpected drop in August payrolls fanned recession fears. The Street is certain the Fed will cut rates, but by how much? And how soon?

by David Bogoslaw

For Wall Street, the debate is over. A Fed rate cut this month now looks like a slam dunk.

U.S. stock indexes took a beating and ended sharply lower on Friday, after the first monthly decline in nonfarm payrolls in four years confirmed fears that the credit crisis has started to work its way through the broader economy beyond the housing sector. The data also all but guarantees the Federal Reserve will cut the Fed funds rate by Sept. 18.

The Dow Jones industrial average dropped 249.97 points, or 1.87%, to 13,113.38 on Friday. The broader S&P 500 slipped 25.00 points, or 1.69%, to 1,453.55. The tech-heavy Nasdaq composite index fell 48.62 points, or 1.86%, to 2,565.70.

The selling was relentless in a very volatile session, with 96% of the stocks in the S&P 500 index ending lower and all but one of the 30 names in the Dow posting losses.

U.S. nonfarm payrolls fell 4,000 in August instead of the 112,000 gain that was anticipated, driven by major losses in the goods-producing, manufacturing and construction industries. While it was the first time jobs declined since July, 2003, the unemployment rate was flat from the previous month at 4.6%. Compounding the gloom were sharp downward adjustments in the June and July job gains. The 126,000 gain in payrolls in June was nearly halved to 69,000 and the July increase was revised to 68,000 from 92,000.

The implications of the jobs data for a significant slowdown in economic growth took a toll on technology stocks, which had escaped the recent market volatility largely unscathed. Semiconductor manufacturers such as Intel Corp. (INTC), were especially weak.

Retail stocks were also down, with Harley-Davidson's (HOG) reduction of its 2007 sales and profit outlooks providing a clue to the impact of the jobs data on consumer spending.

Unlike some economists, John Wilson, chief technical strategist at Morgan Keegan in Memphis (Tenn.), said he didn't consider the August payrolls number an anomaly, given the big downward revisions for June and July. But based on other economic indicators, he predicted that equities are close to finding a bottom and didn't think there was much chance of a major meltdown.

He pointed to the undervaluation of stocks vs. bonds, with the earnings yield on the 12-month forward earnings of the S&P 500 trading at a 38% discount to that on the 10-year Treasuries. That means that for the stocks in the S&P to reach fair value with bonds, they would need to rise 62%.

"Money tends to go where it's treated the best, which is stocks currently," he said, citing the 7.1% yield on the S&P 500 Index and the 4.36% yield on the 10-year Treasury note.

Despite the high volume on Friday, he said he saw signs of sell-first-ask-questions-later activity, which suggests potential for a reversal to the upside on Monday.

But that's not what portfolio managers are expecting, if the 34 surveyed by Ried Thunberg ICAP this week, and who together control $1.3 trillion in assets, can be taken as a representative sample.

The firm's chief economist, Bob Ried, said that 70% of those 34 managers believe the current liquidity crisis will last for another three months or longer.

"That tells you that major portfolio managers are not expecting this to be over any time soon," Ried said.

Fund managers who invest in fixed income assets like government bonds were certainly on the sidelines for the first three days of this work week, judging by the 25% to 50% drop in trading volume in the five most active Treasury issues, he said. He said he would have expected a pickup in activity with investors returning from vacation this week.

"To me, that reflected a kind of paralysis, as opposed to sitting back [among fund managers]," he added.

The payroll numbers also suggest that a decline in consumer spending won't be far behind, as job growth and income gains have been cited as the reasons for firm retail sales up until now.