Stocks could get a lot cheaper in the next few months

The latest employment data from the US suggests that more tough times lie ahead for the world's stock markets. John Stepek explains why.

The US non-farm' payrolls report is one of the most closely-watched pieces of economic data in the world.

It's a monthly report from the Bureau of Labor Statistics which gives the current US unemployment rate, along with the number of jobs created each month.

Like most must-see' economic data, it is a volatile figure. It is frequently revised and it's based on models and assumptions that don't always stand up to close scrutiny. No one in their right mind would invest solely on the basis of a single monthly reading from the series.

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Yet, it still has the power to move markets quite sharply, especially in the short term.

And Friday's data disappointed investors. March saw just 120,000 jobs created, whereas economists had been hoping for 200,000.

So what does this mean for you?

Does the US jobless data mean anything for you?

The US jobless data is just one set of numbers. If your whole investment strategy can be derailed by one unexpected data point, then you should be revising your approach.

The truth is, markets were due a nasty surprise. As my colleague David Stevenson has pointed out a number of times in the Fleet Street Letter, investors have been getting complacent.

Volatility had hit a low in recent months. Meanwhile, Citigroup's Economic Surprise Index (which provides a rough gauge of whether investors are gloomy or pessimistic) has recently rolled over.

In other words, investor optimism has run ahead of reality, which means that economic data are now increasingly giving investors shocks, rather than pleasant surprises.

So markets were due a breather. But will it extend to something longer?

Well, what's perhaps more interesting than the jobless data, is what Federal Reserve chief Ben Bernanke had to say about the jobs recovery.

Now in case you hadn't already noticed, Bernanke is quite keen to play down the US economic recovery. He knows that if he embraces the rally with open arms, then that'll mean no more quantitative easing (QE).

In turn, that would mean all his efforts to push the stock market up, and so promote a wealth' effect, would collapse. He doesn't want that. So he has to keep the market's hope for more money-printing alive. So it's worth remembering that he has a bearish bias.

However, he makes quite a reasonable point on jobs. He notes that the recent apparently strong recovery in employment is "somewhat out of sync with the overall pace of economic expansion." In other words, jobs growth isn't justified by the generally weak underlying economy.

You've heard of downsizing' now it's time for right-sizing'

What's the explanation? Bernanke reckons that what happened is that companies slashed jobs so fast during 2008 and 2009, that they over-reacted to the crisis. Now they are having to hire people just to get back to normal' levels.

Polling company Gallup calls this 'right-sizing'. The trouble is, once this 'right-sizing' is finished with, then we might well see the jobs recovery slow down. Also perhaps perversely - as optimism picks up, it might make the jobless data look worse as more people re-enter the labour market.

How does that work? Well, lots of people had given up looking for jobs altogether, and so dropped out of the pool of officially unemployed people. But if they see more chance of getting one, they'll leave the ranks of the discouraged' workers, and start to feature in the headline data again. So chances are that the jobless data could start to look worse.

This right-sizing' could also have an impact on corporate profit margins. As we've noted several times already, corporate profit margins are currently at record levels. But if companies are having to right-size' and hire more staff again, then that means they have run out of space to cut costs.

If the economy isn't growing fast enough to boost sales to a level where they can compensate for the loss of gains from cost-cutting, then earnings could start to disappoint. And given the state of the rest of the global economy, it certainly seems unlikely that earnings will surprise on the upside.

Sales from Europe are already being squeezed same-store sales from fast-food giant McDonald's fell short of estimates in February, due to European consumers cutting back.

On top of that, China can't be relied on to keep global growth ticking along either. The country returned to having a trade surplus in March. In other words, it exported more goods than it imported.

That might sound like good news, but chances are it's not. For a start, the country wants to increase domestic demand falling imports don't bode well for that mission. Also, as the FT notes, many imports into China go back out again in the form of finished goods. So a slowdown in imports may point to a drop-off in demand for exports.

On top of that, Chinese inflation came in above expectations in March, at an annual rate of 3.6%. That'll make it tougher for China's central bankers to relax monetary policy, even if they wanted to. (For more on why we think China could be a real threat to the global economy, have a look at this report).

In short, "while the US economy is the cleanest shirt in the hamper at the moment" as one strategist tells Bloomberg, "we're only talking about an economy that's motoring along at a sub-par pace."

So we could be facing a gloomier outlook in the run-up to the summer. And if Europe kicks off again, that could trigger an even bigger sell-off. That of course, would give Bernanke the excuse he needs to print more money. In the meantime, if you've got your eye on any specific stocks or markets, you might well get a chance to buy them cheaper in the months ahead.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.