The labor market is simultaneously hot 🔥, cooling 🧊, and kinda problematic 😵💫
Plus a brief note on Silicon Valley Bank, and a charted review of the macro crosscurrents 🔀
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Stocks tumbled last week, with the S&P 500 falling 4.5%. The index is now up 0.6% year to date, up 7.9% from its October 12 closing low of 3,577.03, and down 19.5% from its January 3, 2022 closing high of 4,796.56.
Market volatility spiked as Silicon Valley Bank became one of the largest banks in history to fail. (You can read explainers at Bloomberg, Reuters, WSJ, and Yahoo Finance.) Treasury yields fell by the most since the financial crisis as traders and investors fled to safety.
One thing that’s for sure is few predicted this was coming. While it’s popular to say “something always breaks after a Fed tightening cycle,” few specifically identified a big bank failure on the top of their lists of big risks.
As I wrote last week (and according to TKer Truth No. 8), “The most destabilizing risks are the ones people aren’t talking about.“ In other words, markets tend to fall sharply when little known risks emerge as traders and investors rush to price in the adverse scenario they believe is likely to happen.
What actually happens could be worse than what markets are reflecting. It could also be better. I will say it’s probably a good thing that a lot of the people who were around for the last big bank failure are still around today.
At this point, I don’t have much more to add as the story is still unfolding and the regulatory response has yet to be understood. As such, I’d also caution against jumping to any conclusions offered by the many commentators arguing why this is or isn’t a big deal.
All that said, the failure of Silicon Valley Bank wasn’t the only market-moving event last week. Specifically, let’s focus on the somewhat-befuddling labor market and how it relates to the Fed’s ongoing inflation fight.
The labor market is a lot of things 🤦🏻♂️
Stocks fell after Federal Reserve Chair Jerome Powell told Congress: “the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hike.”
In other words, stronger-than-expected economic reports mean the Fed-sponsored market beatings will continue.
That brings us to the labor market where news headlines can sometimes be confusing. Is the market strong? Is it deteriorating? Is good news about jobs actually good? Or is it bad?
The answers to all of those questions are: Yes.
To understand this, let’s first check in on the data.
According to Bureau of Labor Statistics (BLS) data released Friday, U.S. employers added a respectable 311,000 jobs in February. That’s down from January’s 504,000 gain, and it confirms a downward trend from earlier in the economic recovery.
Nevertheless, the jobs number is also consistent with the narrative that demand for labor is robust as the number of people employed continues to break records.
During the period, the unemployment rate rose to 3.6% in February, up slightly from the 54-year low of 3.4% reported the month prior.
The main reason the unemployment rate climbed was that 419,000 people entered the labor force, bringing the labor force participation rate up to 62.5%.
Rising labor force participation means more people are applying to open jobs, which helps loosen labor market tightness and relieve inflationary pressures. Indeed, average hourly earnings increased by just 0.2% month-over-month in February, the smallest increase in a year. While monthly figures can be noisy, the rolling three-month average confirms wages are cooling.
Entrants into the labor force are entering a market with lots of jobs.
According to the January Job Openings & Labor Turnover Survey released Wednesday, there were 10.82 million job openings in January, down from 11.23 million in December. While this measure has been cooling noticeably, it remains well above pre-pandemic levels.
During the period, there were 5.69 million unemployed people — meaning there were 1.9 job openings per unemployed person. This is one of the most obvious signs of excess demand for labor.
Layoff activity picked up during the period. In January, there were 1.72 million layoffs, which brought the layoff rate up to 1.1%. Directionally, the acceleration in layoff metrics is discouraging. However, the levels continue to be relatively low.
Despite ongoing news coverage of layoffs — which the Federal Reserve recently characterized as “scattered reports” — hiring is the much bigger story. There were 6.37 million hires in January.
Initial claims for unemployment benefits — the most up-to-date of the major labor market stat — came in at 211,000 during the week March 4, up from 190,000 the week prior. While the number is up from its six-decade low of 166,000 in March 2022, it remains near levels seen during periods of economic expansion.
Simultaneously 🔥, 🧊, and 😵💫
There are lots of seemingly conflicting headlines in the news about the labor market, and they might all be true.
Here are three ways to characterize the labor market that I think are all fair.
Hot: There is an overwhelming amount of evidence that shows demand for labor remains robust. Metrics like job openings suggest there is a tremendous amount of excess demand in the economy, which can absorb a lot of stress before metrics like unemployment tick higher in a material way. This is why a growing number of experts believe the risk of a hard landing in the economy is low.
Cooling: While most labor market metrics remain hot, they aren’t as hot as they were earlier in the economic recovery. This is what the Federal Reserve has intended as it has increasingly tightened monetary policy in its effort to cool inflation. While the trends may be unsettling, they would have to deteriorate much more before approaching recessionary levels, and that could take months.
Problematic: The labor market is cooling but it’s not cool — it’s very much hot. And while many measures of inflation are cooling alongside cooling labor market metrics, inflation remains significantly above the Fed’s 2% target. That means the Fed will continue to implement monetary policy in ways that continue to rein in economic activity and employment. It’s why we continue to talk about how good news (about demand) is bad news (for inflation).
Perspective certainly plays a role in how someone characterizes the labor market: employers having to pay up as they compete for limited talent will tell you the labor market it hot; professional forecasters will tell clients economic storm clouds are gathering as the market cools; and policymakers responsible for getting inflation down will emphasize how the ongoing mismatch in labor supply and demand is problematic.
For investors, it’s kinda complicated. Recessions always come with sharp downturns in earnings, which is bad because earnings are the most important long-term driver of stocks. So labor market strength is a good thing, as it limits the risk of an economic hard landing.
But as I’ve been writing for about a year (here and here), the Fed will act in ways unfriendly to the financial markets as long as inflation is significantly above 2%. That’s because tighter financial conditions will slow the economy, which will lead to deteriorating labor market demand, which in turn should cause wages to cool, which they believe will cause inflation to come down. And based on Fed Chair Powell’s comments last week, it seems the central bank’s battle with inflation is far from over.
Unless inflation comes down for some other reason, expect the labor market to continue to cool from hot levels as it remains problematic in the Fed’s eyes.
The next datapoint on this front comes on Tuesday with the next scheduled release of the February Consumer Price Index.
Related from TKer:
You should not be surprised by the strength of the labor market 💪
The bullish 'goldilocks' soft landing scenario that everyone wants 😀
Beware alarming business stories that get a lot of news coverage 🗞️
It's an economic quandary and the Fed sees only one way out 🧩
That’s interesting 💡
Globally, we’re still a long way from gender parity in the workplace. From S&P Dow Jones Indices: “The U.K. is the only region where women cross the 40% threshold for board membership and across total workforce, with Europe and the U.S. closely following. Within the S&P 500®, women represent 39% of total workforce roles and close to 33% of board appointments.“
Reviewing the macro crosscurrents 🔀
There were a few notable data points from last week to consider:
👆 There was a lot of labor market data, which we covered above.
⛓️ Supply chain pressures ease. The New York Fed’s Global Supply Chain Pressure Index— a composite of various supply chain indicators — fell in February and is hovering at levels seen before the pandemic. It's way down from its December 2021 supply chain crisis high. From the NY Fed: "Global supply chain pressures decreased considerably in February and are now below the historical average. There were significant downward contributions by the majority of the factors, with the largest negative contribution from European Area delivery times. The GSCPI’s recent movements suggest that global supply chain conditions have returned to normal after experiencing temporary setbacks around the turn of the year."
Supplier delivery times, trucking capacity, seaborne freight rates, and container terminal bottlenecks have all improved significantly. This is all great news for inflation, which has begun to cool. For more on the improving supply chain, read: We can stop calling it a supply chain crisis ⛓
🔌 Electricity prices are coming down. From the EIA (via Jones Trading’s Dave Lutz): “Natural gas’s current place as the largest source of U.S. electricity generation means that its fuel costs are a significant driver of wholesale electricity prices. For 2023, we forecast that the cost of natural gas delivered to U.S. electric generators will average around $3.50/MMBtu, which would be about half the average in 2022. Although wholesale power prices can be extremely volatile in the short-term, we expect that average wholesale prices this year will be lower than in 2022 as a result of lower natural gas costs.“
For more on energy prices, read: The other side of the surging oil price story 🛢
💳 Consumers are taking on more debt, but levels are manageable. According to Federal Reserve data, total revolving consumer credit outstanding increased to $1.21 trillion in January. Revolving credit consists mostly of credit card loans.
But as Apollo Global economist Torsten Slok notes, “the increase in household incomes has been faster. The net result is that credit card debt is declining as a share of income, see chart below. Combined with strong job growth, solid wage growth, and high excess savings, the bottom line is that the US consumer is in good shape, and there are no signs this is about to change anytime soon.“
For more, read: Consumer finances are in remarkably good shape 💰
🍾 The entrepreneurial spirit is alive. From the Census Bureau: “Total Business Applications in February 2023 were 429,800, up 1.9% (seasonally adjusted) from January 2023.“ Applications continue to trend significantly above pre-pandemic levels.
📈 GDP growth estimates are rosy. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.6% rate in Q1. This is up considerably from its initial estimate of 0.7% growth as of January 27.
For more on the improving economic outlook, read: Economic forecasts are getting revised up, and people aren't thrilled about it 🙃
Putting it all together 🤔
We’re getting a lot of evidence that we may get the bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
The Federal Reserve recently adopted a less hawkish tone, acknowledging on February 1 that “for the first time that the disinflationary process has started.“
Nevertheless, inflation still has to come down more before the Fed is comfortable with price levels. So we should expect the central bank to continue to tighten monetary policy, which means we should be prepared for tighter financial conditions (e.g. higher interest rates, tighter lending standards, and lower stock valuations). All of this means the market beatings may continue and the risk the economy sinks into a recession will relatively be elevated.
It’s important to remember that while recession risks are elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs. Those with jobs are getting raises. And many still have excess savings to tap into. Indeed, strong spending data confirms this financial resilience. So it’s too early to sound the alarm from a consumption perspective.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
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 terrible year, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the previous TKer macro crosscurrents »
For more on why this is an unusually unfavorable environment for the stock market, read: The market beatings will continue until inflation improves 🥊 »
For a closer look at where we are and how we got here, read: The complicated mess of the markets and economy, explained 🧩 »
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.
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%.
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.
700+ reasons why S&P 500 index investing isn't very 'passive'💡
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. From January 1995 through April 2022, 728 tickers have been added to the S&P 500, while 724 have been removed.
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.
When the Fed-sponsored market beatings could end 📈
At some point in the future, we’ll learn a new bull market in stocks has begun. Before we can get there, the Federal Reserve will likely have to take its foot off the neck of financial markets. If history is a guide, then the market should bottom weeks or months before we get that signal from the Fed.
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.
'Past performance is no guarantee of future results,' charted 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. According to their research, 29% of 791 large-cap equity funds that beat the S&P 500 in 2019. Of those funds, 75% beat the benchmark again in 2020. But only 9.1%, or 21 funds, were able to extend that outperformance streak into 2021.
One stat shows how hard it is to pick market-beating stocks 🎲
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 22% of the stocks in the S&P 500 outperformed the index itself from 2000 to 2020. Over that period, the S&P 500 gained 322%, while the median stock rose by just 63%.
Here’s some info on how the index is constructed, according to the NY Fed: “We use the following subcomponents of the country-specific manufacturing PMIs: ‘delivery time,’ which captures the extent to which supply chain delays in the economy impact producers—a variable that may be viewed as identifying a purely supply-side constraint; ‘backlogs,’ which quantifies the volume of orders that firms have received but have yet to either start working on or complete; and, finally, ‘purchased stocks,’ which measures the extent of inventory accumulation by firms in the economy. Note that in case of the U.S., the PMI data start only in 2007, so for the U.S. we combine the PMI data with those from the manufacturing survey of the Institute for Supply Management (ISM).“