Phillip Cochran, Series 7 and 63
VP/Chief Investment Officer


Good morning.

Today brings us the ADP jobs number for February. The market had expected to see 200K new jobs but the actual number posted at 158K new jobs, well under expectations, and thus the bond market is now rallying. I would like to note that the yields were all positive on Treasuries prior to the ADP number this morning, although not by much. I would also like to note that the ADP number from last month was revised up from 198K to 237K, interestingly right in line with last month's non-farm payroll number of 236K. I think the takeaway from this is that ADP lacks the precision to be a solid indicator of what to expect from the non-farm payroll (NFP), but it cannot be ignored.

For those that are not used to these numbers, please allow me to explain where they come from. First of all, the NFP comes from the Bureau of Labor and Statistics (BLS) and on the Friday of the first full week of each month it posts the prior month's new-jobs-created as determined by the BLS. The ADP number, posts on the Wednesday of the first full week of each month and is compiled and reported by ADP Employer Services. ADP data is compiled from their 24 million employees from all 19 of the major North American Industrial Classification (NAICS) sectors. Most in the market regard the NFP as the true number but look at the ADP to offer some insight each month as to what to expect from the NFP.

Today's report is to be considered disappointing, and as such, bond yields are falling due to a rally in the bond market. A rally in the bond market simply means that bonds are being purchased more than sold, and that the prices are rising or rallying. As bond prices increase, the yields are inversely affected and that is why we see bond yields fall during a rally. Usually a bond rally is accompanied by a stock market sell-off, meaning stocks are being sold more than purchased and money is running into bonds (I would bet you have all heard the term "flight to quality"). Rally's in the bond market represent a flight to quality. That is also why every bit of negative news in the economy drives yields down. When you think stock values will decline, you sell stocks on the high and buy bonds to protect your capital.

Along those lines, we are seeing Berkshire Hathaway and other large hedge fund managers starting to dump some of their U.S. stocks on expectations that earnings will begin to lag this year. I think that the recession in Europe, accounting for roughly 40% of U.S. corporate revenues, and the fear of hyper-inflation are causing the fund managers to lose faith in the earnings potential of U.S. corporations and thus expecting a decline in stock value. We see their point. The expectation that rates or yields are going to rise this year should really be carefully thought out because we do not see any reason for that to occur.

Let us submit that the 3yr and under bonds have been resilient in their pricing as of late, but that may (should) not hold. If you have buckets to fill under 3 years, look at these bonds and start buying because you will wish you had when the yields decline further. We could see a decent sell-off this Friday if the NFP number is a good one. I would caution that the expectations at this point are for 198K new jobs and even though ADP is never accurate, it might be a lead indicator that Friday's numbers could disappoint and that would result in a big rally. Short bonds are already under serious pressure due to their short-term, a decent rally could slaughter the prices we can offer today and then you will be stuck in cash for the remainder of those terms. We would grab some yield in the short callables and bullets while you can.