Job growth, subprime on investors' minds

Stocks posted solid 2nd-quarter gains but rising interest rates and the subprime mortgage mess are a concern.

NEW YORK (Reuters) -- Investors are hoping this week brings some answers to the question of whether an improving U.S. economy unleashes inflationary forces, and one place to look will be in the government's June employment report.

At the same time, the potential for defaults in subprime loans to spill over to the general economy remains a concern. Nervousness that tighter credit may affect the availability of financing for buyouts prompted investors to sell banks' and brokers' shares on Friday, which helped cut short a morning rally.

In this holiday-shortened week, the most significant data, the June payrolls report, will come on Friday.

U.S. financial markets will be closed on Wednesday, July 4, for the Independence Day holiday and the New York Stock Exchange will close early, at 1 p.m. ET on Tuesday.

Stocks can't muster turnaround

Last month, investors were cheered by news that employers added 157,000 jobs in May. But a Reuters poll of economists found forecasts for weaker job growth in June: analysts on average said payrolls added 120,000 jobs last month.

Bill Dwyer, chief investment officer at MTB Investment Advisors in Baltimore, expects growth of 120,000 to 130,000 jobs. "I think the economy is still chugging along and the consumer is in pretty decent shape," Dwyer said. He added that with decent economic fundamentals, no recent announcements of major layoffs and signs that manufacturing is picking up, the payrolls report should be at or a little better than the consensus.

Other reports due during the week include the Institute for Supply Management's readings on June manufacturing, on Monday, and the services sector, on Thursday. The Reuters survey forecasts that ISM's June index of national factory activity will be unchanged at 55.0. The ISM services index is expected to drop to 58.0 from 59.7 in May. Any reading above 50 points to growth in the sector.

Al Kugel, chief investment strategist at Atlantic Trust in Chicago, noted that some recent data from regional Federal Reserve banks has been good. He said he expects the ISM data to be strong. "People need some new information to become more bullish and the ISM could be the trigger," he said.

The stock market turned in a strong performance for the second quarter, but has hit a wall in recent weeks after Treasury bond yields climbed above 5.0 percent and problems surfaced at two Bear Stearns hedge funds that held investments in subprime loans, home mortgage loans to borrowers with weak credit.

Cracks in the buyout boom

For the second quarter, the Dow industrials jumped 8.5 percent, the S&P 500 rose 5.8 percent and the Nasdaq gained 7.5 percent. So far for the year, the Dow is up 7.6 percent, the S&P is up 6 percent and the Nasdaq 7.8 percent.

After losing ground Friday, the Dow finished last week up 0.4 percent, the Nasdaq gained 0.6 percent and the S&P ended little changed.

In the week ahead, Tuesday will bring its fair share of numbers. A government report on May factory orders is due that day, along with car and truck sales in June. After a lull this week, S&P 500 companies' earnings will begin to trickle out the following week and then the quarterly deluge begins later in July.

Bob Millen, co-portfolio manager of The Jensen Portfolio, a $2.3 billion mutual fund, noted that S&P 500 earnings growth is down significantly from the double-digit readings of a year ago. He said price-to-earnings multiples are unlikely to expand, and that companies generating significant revenue from outside the United States are the best bets now.

News of a probe into two Bear Stearns (Charts, Fortune 500) hedge funds heavily invested in subprime mortgages added to investors' worries last week that the potential fallout could spread throughout the banking industry. One company was forced to postpone a bank loan and another firm delayed the pricing of a $1.1 billion high-yield bond offering.

Mergers fail to lift media stocks

Referring to the problems in subprime debt, which have devastated some hedge funds that made heavy bets in the sector, RiverSource Investments chief market strategist David Joy said he believes that "it's the primary preoccupation of equity investors and that is going to continue next week.

"The issue is: 'Does it result in a tightening of lending standards that could spill over into a general credit tightening?' That's the biggest concern."

As for the week's statistics, Joy said he will be watching the average hourly earnings figure that is included with the payrolls data, as well as the prices paid numbers in the ISM reports.

"Our view is that inflationary pressures are probably going to increase in the second half of the year" but at a modest rate as the economy picks up steam, Joy said.