US markets: Jobs news looks up

Investors have looked past some mixed earnings results and focused on improvements in economic data, helping stocks to notch up some solid gains.

The improvements in equity markets in the early weeks of 2012 are particularly notable given that stockmarket rises have been global in nature. In fact, the past three weeks mark the first time since 2007 that markets in the US, Europe and China have all advanced at the beginning of a year. In spite of the gains, however, it is important to point out that mutual fund flows are still showing that investors are moving out of equities, indicating that aversion to risk remains high.

One of the key recent economic data releases showed that US jobless claims fell by 50,000 last week to 352,000. That drop represents the largest weekly decline since 2005 and suggests that the January payrolls report could be a strong one. Our estimate is that when that data is released in a couple of weeks, it will show that roughly 50,000 new jobs will have been created.

As we have been saying for some time, improvement in the employment market is a critical factor in helping to create positive ‘feedback loops’ for the economy, and it does appear to us that employment data is slowly continuing to get better.

It is still quite early in the fourth quarter 2011 earnings season, but results to date have been mixed and are weaker than they have been in recent quarters. Roughly 15 per cent of companies have reported, with a little more than half delivering better than expected results. At this point, it looks like overall earnings will exceed estimates by roughly 1 per cent to 2 per cent, the lowest rate we have seen in some time.

At present, analysts are downgrading their 2012 earnings forecasts. The current bottom-up consensus estimates are that earnings will grow by roughly 12 per cent in 2012. Our guess is that growth will come in at around half that rate.

The recent bounce in stocks and other riskier assets can be attributed to a combination of some improved US economic data, a lack of significant new negatives in the euro debt crisis and further evidence of a soft economic landing in China. For the rally to continue, at least two developments need to occur. The first is that we need to see policymakers in the euro area continue to stabilise conditions. The second is that we need to see global economic data continue to improve enough to support growth in corporate earnings.

Regarding the first, it does appear that the European Central Bank is working diligently to address the weakness in the European banking system, which was the source of much concern in 2011.

While we still expect to see a recession in Europe and while some of the less competitive European countries will likely face fiscal and debt challenges for years to come, we do believe that contagion risks can be contained if global economic growth continues – and we believe it will, at a subpar pace.