Stocks made new record highs, with the S&P 500 setting a closing high of 5,157.36 on Thursday and reaching an intraday high of 5,189.26 on Friday. For the week, the S&P shed 0.3%. The index is now up 7.4% year to date and up 43.2% from its October 12, 2022 closing low of 3,577.03.
Productivity has been improving, and that’s a good thing. Not only does it mean employers are getting more output per worker, it also helps keep inflation tame. Better productivity is also good news for the stock market as it acts as a tailwind for profit margins, which is good for earnings growth and it may justify higher valuation premiums.
According to BLS data released Thursday, labor productivity increased 3.2% in the fourth quarter of 2023, the third straight quarter of gains. During the period, output increased 3.5% while hours worked increased by just 0.3%.
There are lots of reasons to explain why productivity might be improving.
Fewer are quitting 👋
Less churn in the labor market is one reason. In January, 3.39 million workers quit their jobs. This represented just 2.1% of the workforce, which is below the prepandemic trend.
“In the early days of the pandemic, labor markets were red hot, driving up the rate of quits and hires,” Renaissance Macro’s Neil Dutta wrote on Monday. “Employers were running around with fishnets trying to find people, and workers understood their leverage, quitting jobs in search of better paying ones. A little heat in the job market is good, but you can have too much of a good thing. It’s hard to establish productivity if folks are not actually staying in their positions for that long!”
That makes sense. When you’re new to a job, you’re probably spending a lot of time learning the ropes. The longer you stay in a job, the better you get at it.
As Dutta previously observed, employment cost index growth and the quits rate peaked at about the same time two years ago and have been trending lower together ever since.
There are more new businesses 📂
The boom in new business formation may be another reason why productivity is improving.
According to monthly Census Bureau data, business applications and formations have been trending significantly above pre-pandemic levels.
“That’s important since the slowing pace of business dynamism and lack of new business formation in the 2000s was said to be a reason behind the sluggish growth in productivity over that period, particularly after 2005,” Dutta wrote. “The rise in business formation suggests that people are willing to take on additional risk, and that’s probably important in lifting productivity.”
Indeed, some of the world’s most successful businesses were started by entrepreneurs who cut their teeth at legacy companies, only to leave because they saw an opportunity to execute more efficiently.
And poorly managed unprofitable businesses tend to layoff workers, while better managed profitable ones tend to hire.
“Productivity improves when resources are reallocated from less productive to more productive businesses,” Oxford Economics’ Ryan Sweet wrote on Tuesday.
The advent of AI 🤖
Of course, there’s also the rapid uptake of artificial intelligence (AI) technologies.
“There is a notable amount of overlap among the industries discussing operational efficiency most prevalently and those that have the potential to realize more significant AI-driven efficiency gains,” Morgan Stanley analysts wrote in February. “We see AI-driven productivity adding an additional 30 bps to 2025 net margin for the S&P 500 (13.0% net margin in the base case) though we believe risk is skewed to the upside/our bull case in this respect — 50 bps of added impact.“
But as the analysts note, it could be a little while before we realize significant tangible benefits from the adoption of AI.
“The news media is littered with discussions about artificial intelligence and the resulting productivity boom,” Dutta said. “Just because there is a technological breakthrough, productivity miracles don’t necessarily follow right away. It takes time for the technology to make its way through the economy and time for workers to gain the skills needed to make the most use out of technological advances.“
Zooming out 🔭
There isn’t a single metric that does a great job of explaining the state of productivity in the economy. Part of the issue is there are so many ways to think of productivity conceptually. As such, improved productivity manifests in many forms.
One thing I’m pretty confident of is that everyone wants everything and everyone else to be more productive. Employers want their workers and equipment to be more productive so their companies can be more profitable. Workers want to be more productive, and we’d all love to get more done with less time and effort.
At home, everyone wants to be more productive in all they do — because life is short, and who’s got the time? And being productive doesn’t necessarily mean being active all the time. A great vacation or a good night’s sleep can be productive if it makes you refreshed and energized, which in turn can make you more productive in your other activities.
All of these needs and desires incentive people and businesses to come up with new ways to be productive. And all of this is bullish for economic activity, earnings growth, and stock prices in the long run.
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Related from TKer:
BofA raises its target for the S&P 500 📈
Last Sunday, BofA’s Savita Subramanian raised her year-end target for the S&P 500 to 5,400 from 5,000. This is her first revision from her initial target.
“Bull markets end with euphoria — we're not there yet,” she wrote. “Sentiment has improved, but areas of euphoria are limited (AI, GLP-1).”
Subramanian is not alone in tweaking her forecasts. Her peers at Barclays, UBS, Goldman Sachs, RBC, and CFRA are among those who’ve already raised their targets.
Don’t be surprised to see more of these revisions as the S&P 500’s performance, so far, has exceeded many strategists’ expectations.
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
👍 The labor market continues to add jobs. According to the BLS’s Employment Situation report released Friday, U.S. employers added 275,000 jobs in February. It was the 38th straight month of gains reaffirms an economy with robust demand for labor.
Total payroll employment is at a record 157.8 million jobs, up 5.5 million from the prepandemic high.
The unemployment rate — that is, the number of workers who identify as unemployed as a percentage of the civilian labor force — rose to 3.9% during the month. While it’s above its cycle low of 3.4%, it continues to hover near 50-year lows.
For more on the labor market, read: Labor market: How cool will it get? 🥶
📉 Wage growth ticks lower. Average hourly earnings rose by 0.1% month-over-month in February, down from the 0.5% pace in January. On a year-over-year basis, this metric is up 4.3%, a rate that’s generally been cooling but remains elevated.
For more on why the Fed wants wage growth to cool, read: A key chart to watch as the Fed tightens monetary policy 📊
📈 Job switchers still get better pay. According to ADP, which tracks private payrolls and employs a different methodology than the BLS, annual pay growth in February for people who changed jobs was up 7.6% from a year ago. For those who stayed at their job, pay growth was 5.1%.
For more on the implications of cooling inflation, read: The bullish 'goldilocks' soft landing scenario that everyone wants 😀
💼 Job openings tick lower. According to the BLS’s Job Openings and Labor Turnover Survey, employers had 8.86 million job openings in January. While this remains elevated above prepandemic levels, it’s down from the March 2022 high of 12.03 million.
During the period, there were 6.12 million unemployed people — meaning there were 1.4 job openings per unemployed person. This continues to be one of the most obvious signs of excess demand for labor.
For more on job openings, read: Were there really twice as many job openings as unemployed people? 🤨
👍 Layoffs remain depressed, hiring remains firm. Employers laid off 1.57 million people in January. While challenging for all those affected, this figure represents just 1.0% of total employment. This metric continues to trend below pre-pandemic levels.
Hiring activity continues to be much higher than layoff activity. During the month, employers hired 5.69 million people.
For more on why this metric matters, read: Watch hiring activity 👀
🤔 People are quitting less. In January, 3.39 million workers quit their jobs. This represents 2.1% of the workforce, which is below the prepandemic trend.
A low quits rate could mean a number of things. It could mean more people are satisfied with their job. It could mean workers have fewer outside job opportunities. It’s associated with cooling wage growth. It could mean productivity will improve as fewer people are entering new unfamiliar roles.
💪 Labor productivity is up. From the BLS: “Nonfarm business sector labor productivity increased 3.2% in the fourth quarter of 2023… as output increased 3.5% and hours worked increased 0.3%. … Annual average productivity increased 1.3% from 2022 to 2023.”
💼 Unemployment claims remain low. Initial claims for unemployment benefits stood at 217,000 during the week ending March 2, unchanged from the week prior. While this is above the September 2022 low of 182,000, it continues to trend at levels historically associated with economic growth.
For more, read: Labor market: How cool will it get? 🥶
💳 Card data suggests spending is holding up. From JPMorgan: “As of 28 Feb 2024, our Chase Consumer Card spending data (unadjusted) was 1.8% below the same day last year. Based on the Chase Consumer Card data through 28 Feb 2024, our estimate of the US Census February control measure of retail sales m/m is 0.28%.“
For more on what’s bolstering personal consumption activity, read: Consumer finances are somewhere between 'strong' and 'normal' 💰
⛽️ Gas prices rise. From AAA: “Pump prices have maintained a steady march higher, rising eight cents since last week to $3.39. More expensive oil is a likely culprit, as crude accounts for nearly 60% of pump prices. The cost for a barrel of oil is edging closer to $80, about $10 more per barrel than a few months ago.”
For more on energy prices, read: The other side of the oil price story 🛢
🏠 Mortgage rates tick lower. According to Freddie Mac, the average 30-year fixed-rate mortgage fell to 6.88% from 6.94% the week prior. From Freddie Mac: “Evidence that purchase demand remains sensitive to interest rate changes was on display this week, as applications rose for the first time in six weeks in response to lower rates. Mortgage rates continue to be one of the biggest hurdles for potential homebuyers looking to enter the market. It’s important to remember that rates can vary widely between mortgage lenders so shopping around is essential.”
For more on mortgages and home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
👍 Services surveys signal growth, but cooling growth. From S&P Global’s February U.S. Services PMI: “Output rose for a thirteenth successive month, the rate of growth falling only slightly from January's seven-month high. New business inflows have now risen for four straight months. Total new order growth nonetheless slipped to the weakest in three months, as new business from abroad dipped back into contraction territory. Pressure on capacity dissipated as backlogs of work fell, aided by a further rise in employment. Business confidence dropped to the lowest since last November, however, slipping below the survey's long-run average.“
The ISM’s Services PMI ticked lower in February but continued to signal growth.
It’s worth remembering that soft data like the PMI surveys don’t necessarily reflect what’s actually going on in the economy.
For more on this, read: What businesses do > what businesses say 🙊
⛓️ Supply chain pressures tightens a little. The New York Fed’s Global Supply Chain Pressure Index — a composite of various supply chain indicators — tightened modestly in February but remains below levels seen even before the pandemic. That's way down from its December 2021 supply chain crisis high.
For more on the supply chain, read: We can stop calling it a supply chain crisis ⛓
📈 Near-term GDP growth estimates look good. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.5% rate in Q1.
For more on economic growth, read: Economic growth: Slowdown, recession, or something else? 🇺🇸
🏛️ The Fed is watching the data. On Wednesday and Thursday, Federal Reserve Chair Jerome Powell delivered the central bank’s semiannual Monetary Policy Report to Congress. There wasn’t a lot of news to report. Powell and the Fed acknowledge that inflation rates have come down considerably and that they’re unlikely to hike rates further. But they also reiterated that they’d like to have “greater confidence” that inflation is under control before they decide to make adjustments on interest rate policy. From Powell’s prepared remarks:
While inflation remains above the Federal Open Market Committee's (FOMC) objective of 2%, it has eased substantially, and the slowing in inflation has occurred without a significant increase in unemployment. As labor market tightness has eased and progress on inflation has continued, the risks to achieving our employment and inflation goals have been moving into better balance.
…
We believe that our policy rate is likely at its peak for this tightening cycle. If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year. But the economic outlook is uncertain, and ongoing progress toward our 2% inflation objective is not assured. Reducing policy restraint too soon or too much could result in a reversal of progress we have seen in inflation and ultimately require even tighter policy to get inflation back to 2%. At the same time, reducing policy restraint too late or too little could unduly weaken economic activity and employment. In considering any adjustments to the target range for the policy rate, we will carefully assess the incoming data, the evolving outlook, and the balance of risks. The Committee does not expect that it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.
While the Fed will continue to play a big role in the markets and the economy, I’m not convinced they’re as significant as they were during the height of pandemic and the inflation crisis.
For more, read: The stock market is unbothered by the shrinking number of expected rate cuts 🤷🏻♂️ and Whether or not the Fed cuts rates is not the right question 🔪
Putting it all together 🤔
We continue to get evidence that we are experiencing a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to get inflation under control. While it’s true that the Fed has taken a less hawkish tone in 2023 and 2024 than in 2022, and that most economists agree that the final interest rate hike of the cycle has either already happened, inflation still has to stay cool for a little while before the central bank is comfortable with price stability.
So we should expect the central bank to keep monetary policy tight, which means we should be prepared for relatively tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms — meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.
Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.
Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
10 truths about the stock market 📈
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
The makeup of the S&P 500 is constantly changing 🔀
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
The key driver of stock prices: Earnings💰
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Stomach-churning stock market sell-offs are normal🎢
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
High and rising interest rates don't spell doom for stocks👍
Generally speaking, rising interest rates are not welcome news for the economy and the stock market. They represent higher financing costs for businesses and consumers. All other things being equal, rising rates represent a hindrance to growth. However, the world is complicated, and this narrative comes with a lot of nuance. One big counterintuitive piece to this narrative is that historically, stocks have actually performed well during periods of rising interest rates.
How stocks performed when the yield curve inverted ⚠️
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
How the stock market performed around recessions 📉📈
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
In the stock market, time pays ⏳
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
What a strong dollar means for stocks 👑
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
Economy ≠ Stock Market 🤷♂️
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Warren Buffett's 'fourth law of motion' 📉
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
Most pros can’t beat the market 🥊
According to S&P Dow Jones Indices (SPDJI), 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500 in 2023. As you stretch the time horizon, the numbers get even more dismal. Over a three-year period, 79.8% underperformed. Over a 10-year period, 87.4% underperformed. And over a 20-year period, 93% underperformed. This 2023 performance follows 13 consecutive years in which the majority of fund managers in this category have lagged the index.
The sobering stats behind 'past performance is no guarantee of future results' 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 318 large-cap equity funds were in the top half of performance in 2020. Of those funds, 39% came in the top half again in 2021, and just 5% were able to extend that streak through 2022. If you set the bar even higher and consider those in the top quartile of performance, just 7% of 156 large-cap funds remained in the top quartile in 2021. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2022.
The odds are stacked against stock pickers 🎲
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.
This is the one letter I pay for, and with every post and look back at past posts, I know why.