Mixed Economic Data

The stock market recovered from Wednesday’s sharp
drop. The major indices traded higher for most of the day, before a late
sell-off drove them in onto the red. The S&P 500 closed less than a
half-point form support at 1,301.

But while investors seem to be feeling at least slightly better about a
budget deal getting done before Tuesday, another negative catalyst has
reared its head — weak economic data.

Why Bonds are Rallying

Another day, and still no agreement on a 2011 budget
in Congress. Surprisingly though, the stock market is not really being
affected by the impasse. Sure, the major indices are down slightly again
today, but I think we can all imagine that it could be much worse.

Treasury bond prices have been choppy, with big $3 price swings on the
chart of the iShares Barclays 20+ Year Treasury Bond ETF (TLT) in July. But
overall, bonds are holding up well, and this tells us clearly that no one
expects the U.S. government to default on its bond payments.

Tech Market Heats Up: What

Congress and the Obama administration are at it
again. Talks broke down over the weekend, which is a familiar development.
The impasse is certainly weighing on the stock market.

Precious metals are rallying, bonds and stocks are down. Of these assets,
it’s the move in bonds that are most telling. Bond prices are falling, and
yields are rising, because failure to pass a budget opens the door for a
downgrade of U.S. debt from the ratings agencies. That, in turn, raises
borrowing costs (interest rates) because repayment is suddenly less
certain.

Treasury Bond Yields are Falling

Treasury bond yields are falling following a sharp drop in U.S. Nonfarm
Payrolls numbers. 10-year Treasury bond yields fell below 3% for the first
time since the depths of the financial crisis.

Interestingly, the weak employment numbers and the drop in Treasury yields
coincides with the end of the Fed’s bond-buying program known as QE2.

QE2 was designed to increase the supply of cheap money and encourage
investors to enter the stock market. But with QE2 scheduled to end in just
a few weeks, investors are beginning to exit the most risky stocks.

When uncertainty rises in the stock market, investors start buying
defensive assets like dividend stocks. High-yielding dividend stocks are
especially attractive in the current environment because they are among the
only assets that can guarantee investors a return that will beat inflation
and Treasury bond yields.

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Wall Street’s Herd Mentality

As expected, today’s Nonfarm Payroll number was
just as bad as the ADP Payroll indicated it might be. Expectations were
that 165,000 jobs were added in May. The reality is that we got only
54,000 jobs.

Soft patch, indeed.

The economy has been adding an average of 220,000
jobs for three months running. 54,000 is a big miss, big enough to push
the unemployment rate up to 9.1%.