Stocks face tough week amid faltering U.S. jobs market

“It was disappointing, it was the weakest in a number of months but there are still jobs being created,” said Jennifer Lee, senior economist at BMO Capital Markets.

“Expectations were riding really high ahead of this number because of all the positive indicators that we have seen lately.”

For example, reports last week showed the service sector expanded at a healthy clip in March and increased hiring while a survey by payroll firm ADP had said the private sector had created 209,000 jobs last month.

The Toronto stock market lost 289 points or 2.33% last week, leaving the TSX up just 1.23% year to date.

Even before the release of the American jobs report, traders were set for some unpleasant surprises amid diminished earnings expectations.

“This is going to be basically reality bites,” said Gavin Graham, president of Graham Investment Strategy.

“You should not expect good strong growth in earnings in this first quarter.”

As the U.S. reporting season gets set to kick off Tuesday with results from aluminum giant Alcoa Inc., international brokerage and consulting firm Brockhouse Coopers has pointed out that 462 U.S. companies have warned that earnings have headed lower over the last three months, while only 181 companies have guided earnings higher.

Graham sees a couple of forces at work. He observed that companies had very strong growth year on year in the first quarter of 2011 over 2010.

“And so you had a very high benchmark to match, high hurdles to jump over.”

But he adds the most important reason that profits have been so good is profit margins have expanded, but not for the right reasons.

“It’s not that you have had strong top line (revenue) growth — in most cases you haven’t,” he said.

“What you had is very effective cost cutting by companies that have really slashed and burned back in 2008, 2009 and then didn’t take on a lot of new people or spend a lot of money on new equipment to expand capacity — and therefore working their existing equipment and people harder. They have got very productive workers and the highest profit margins in 40 years.”

And Graham points out that companies cannot grow profits by cutting back and making do forever.

Prices for oil and metals also accelerated sharply over the first quarter and Graham thinks that will also adversely affect profits.

For example, copper prices ran up over 13% during the first quarter while West Texas Intermediate crude ran up as much as 10% before settling down somewhat.

Other major U.S. companies reporting this week include Google Inc. and banking giants JPMorgan Chase and Wells Fargo and Co.

The Toronto market likely faces another headwind this week in the form of more worries about the European debt crisis.

After a hiatus for a good chunk of the first quarter, concerns were back on the front-burer as Spain’s bond yields advanced in the wake of a disappointing set of bond auctions last Wednesday.

Spain’s five-year yields climbed 19 basis points to 4.45%, their highest level since January after Spain sold €2.59 billion of bonds versus an intended maximum of €3.5 billion. Yields rose again slightly the following day.

Countries such as Italy and Spain were faced with sharply higher bond yields late last year as investors lacked confidence in their governments to cut deficits and demanded higher premiums for rolling over debt.

The problem receded in December after the European Central Bank made large amounts of money available to eurozone banks at very low interest rates, which in turn was used to buy up government bonds in a program known as long-term refinancing operations (LTROs).

However, the LTRO facility expired at the end of March.

“The fact is the LTROs bought some time which (eurozone countries) haven’t actually used to great effect,” added Graham.

It is a relatively light week for economic data this week from North America this week with the focus on a raft of key economic data from China.

“Everyone will be nervously watching what China reports,” added Lee.

“They’re releasing all their March data, retail sales, industrial production, inflation and GDP comes out at the end of the week. I think whisper numbers are for growth of 8.4% year over year in the first quarter.”

China has been a key prop in lifting the global economy from the recession that followed the 2008 financial crisis.

Growth in the world’s second biggest economy has been of particular benefit to the resource heavy TSX because China’s huge appetite for commodities has lifted prices for oil and metals and boosted share prices of energy and mining companies.

But there has been nervousness for well over a year as the Chinese government sought to slow its strong, double-digit economic growth in order to deal with high inflation.

With price pressures easing, traders are now looking to the Chinese central bank to encourage greater lending in order boost growth.