June employment numbers were released this morning coming in with another monthly decline in payrolls.  According to the release, nonfarm payrolls declined by 467,000 which is a much larger drop than the published 325,000 expectations.  The decline is also much larger than May’s decline which showed 322,000 fewer payrolls.  The official unemployment rate is now pegged at 9.5% inching ever closer to the emotionally significant 10% mark.

The initial reaction in stock futures was a move lower as the report obviously calls into question a widespread assumption that we are experiencing the “green shoots” of economic recovery.  Naturally, bullish investors and pundits will attempt to explain that employment numbers typically lag an economic recovery so we will likely not see job growth until the economic recovery truly is underway and companies have more confidence to hire new employees.

This may be true, but the rate at which we continue to lose jobs has been startling.  Not only are we not improving but employment numbers are actually getting worse! The US economy continues to lose jobs at nearly a half million positions each month and that is using figures that are relatively conservative.  If you factor in less followed but still significant underemployed numbers (workers who took jobs to make ends meet but have accepted major pay cuts) we have a much worse situation than many account for.

Other measures such as average hourly earnings and the average workweek are also very important statistics to be aware of.  In June, the hourly earnings level was flat at $18.53 while analysts had been expecting a slight gain.  The average workweek was 6 minutes shorter as the total number of hours worked was lighter.  This implies that even workers who do not show up in the official unemployment numbers are not seeing any recovery in their income levels and in fact, many are having to take a cut in hours as businesses struggle to meet payroll.  Ironically, many of these workers are having to work harder in order to make up for work done by fellow employees who have been laid off.

As more Americans find themselves out of work, the ripple effect throughout the economic and business world will likely continue.  The banking industry may be one of the hardest hit as loans outstanding continue to be a large problem.  According to a letter by Jim Welsh to investors, FDIC insured banks have recently seen loans 90 days past due increase by $59.2 billion.  Banks have been working hard to beef up their reserves to compensate for loan losses, but despite new capital raised the ratio of reserves to non-current loans has fallen to 66.5% from 74.8% at the end of 2008.  Continued declines in payrolls will likely put even more pressure on these ratios.

Last quarter the market adjusted to the results of the over-hyped bank stress tests.  One of the key assumptions was a “worst case scenario” of 10% unemployment.  Banks were asked to raise enough capital to survive if the economy got so bad that unemployment reached this level, but there was not much consideration given to what would happen if numbers got worse than this 10% level.  Now the number of payrolls lost appears to be increasing instead of moderating and the 10% unemployment level will likely be eclipsed by the end of the year (if not the end of the quarter).

The retail sector will also be affected by an increasingly unemployed consumer.  While there may be some bright spots for discount retailers, the majority of companies in the sector will be fighting against a trend of lower sales.  Specialty shops catering to the affluent may fare the worst as many wealthy customers are now feeling quite pinched and dialing down expensive purchases.  ZachStocks has suggested short positions in various retail stocks like Tiffany & Co. (TIF), CEC Entertainment, Inc. (CEC) and Chipotle Mexican Grill (CMG).  As an alternative to shorting stocks, investors may be able to hedge exposure by buying puts – or simply raising cash levels in order to insulate against a market decline.

Today’s employment report highlights the fact that we are still in a difficult place and not likely to experience a “V shaped” recovery.  Opportunity is still available for flexible and nimble traders, but simply buying and holding a market index may be dangerous in the months ahead.  If you’re worried about your current investment approach, feel free to send me an email and we can discuss options for protecting your wealth.  As we move into the second half of this dynamic year, please use caution and protect your capital.  Remember, the most successful investors gain their edge simply by surviving through difficult markets like these.

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