Big, Positive Surprise in Jobs Data

May Job Loss Shockingly Much Lower Than Forecast

Just 345,000 jobs were lost last month, the smallest decline since last September. The unemployment rate, however, rose to 9.4% -- its highest level since August 1983.

The nonfarm payrolls number is shocking. The drop was less than even the most optimistic forecasts had predicted. A smaller-than-expected drop in construction and temporary jobs appears to have played the biggest role in keeping the losses from being worse.

Adding to the surprise was an improvement in April's job losses. The Labor Department now says 504,000 jobs were cut in April, versus the original estimate of 539,000 losses.

Though the positive surprise in nonfarm payrolls is very welcome, it is important to realize that the economy continues to contract. A smaller number of job losses still means that more people were laid off than were hired. Furthermore, the rising unemployment rate signals that more and more people are unable to find work.

That said, nearly all of the data released over the past couple of months points to the same thing -- the pace of economic deterioration is slowing.

This is a step in the right direction and suggests that a resumption of growth could occur at some point during the second half of the year.

The rally in commodity prices and last month's consumer confidence surveys  suggest many expect conditions to improve over next 6 months.

However, once GDP does return to positive territory, I'm not convinced many people will feel like they are part of an expanding economy.

Rather, I'm worried we could be looking at another jobless recovery. There are thousands of manufacturing jobs in the U.S. that won't be replaced.

Rising foreclosures and credit card defaults will keep the housing market from rebounding. And CFOs will be more focused on keeping costs contained than allowing aggressive expansion.

It's important to realize that though first-quarter earnings were better-than-feared and stocks have rallied since early March, full-year corporate earnings projections haven't moved very much. Though we are seeing the earnings estimate revisions ratio (total positive revisions divided by total negative revisions) improve, top-down profit forecasts for the S&P 500 have been essentially unchanged.

At the same time, stocks and commodities have rallied since March. The upward moves have been fueled by a shift in risk tolerance. Though there are still things that could go bump in the night, I am more optimistic now than I was 2 months ago.

Given this backdrop, investors need to move off of the sidelines, while still remaining selective. Look for companies that could benefit from the recovery, such as Research in Motion (RIMM - Analyst Report), and combine them with less economically sensitive names like Healthsouth (HLS - Analyst Report). At the same time, don't chase stocks whose valuations have become overly optimistic, such as J. C. Penney (JCP - Analyst Report).

As far as the commodities rally, tread carefully, as some companies like Potash Corp. of Saskatchewan (POT - Analyst Report) will be affected by factors outside of the economy. Conversely, other companies, like Weatherford (WFT - Analyst Report) should provide better exposure to the early-cycle improvements.