06.06.22

Stocks and healthy job growth don’t mix 

The last week’s market highlights:

  • In a holiday-shortened week, markets gave back some of the promising gains they made at the end of May. After eking out a modest return during the week’s first three trading days, the S&P 500 Index slumped 1.6% on Friday in the wake of May’s solid jobs report, as investors fretted that the Fed would maintain its aggressive pace of rate hikes to slow down the economy.1
  • In fixed income markets, the yield on the 2-year U.S. Treasury, which closely tracks the outlook for Fed policy, jumped 19 basis points for the week, closing at 2.66%. The 10-year Treasury performed similarly, with its yield reaching 2.96% on Friday.2
  • Crude oil prices continued to climb despite indications from OPEC that it will increase production. European political leaders made new vows to wean their economies off of Russian oil, but details remain murky. West Texas Intermediate Crude Oil finished the week at $119/barrel, its highest level since early March.3
  • This Friday brings May data on U.S. consumer price inflation, which is expected to show a reacceleration driven by higher gasoline prices. Also, the European Central Bank will provide further details on its plans to raise interest rates. Europe has been rocked by energy inflation but has not recovered as quickly or as fully from the pandemic as the U.S. has.

Each week, we present our featured topics in the context of the major themes listed below from Nuveen's 2022 Outlook:Nuveen's 2022 Outlook

  • U.S. economy: No recession this year, although market risks persist.
  • Global economy: Both headline and core inflation likely peaked in March.
  • Policy watch: Fed signals aggressive tightening, but we think fewer rate hikes will be needed.
  • Fixed income: Strong credit fundamentals and attractive valuations favor taking credit risk over duration risk.
  • Equities: Despite further bouts of volatility ahead, equity returns should be positive for 2022 as a whole.
  • Asset allocation: We’re leaning toward “risk-on” positioning. Rebalance prudently.

Quote of the week:

"Let us not take ourselves too seriously. None of us has a monopoly on wisdom.”  –  Queen Elizabeth

Uncertainty prevails for stocks despite solid first-quarter earnings

After stumbling for much of May, U.S. stocks surged as the month drew to a close, buoyed by signs of a gently softening economy. That modest deceleration could allow the Federal Reserve to back off some of its planned rate hikes over the course of this year and into 2023, improving the likelihood of an economic “soft landing.” May’s better-than-expected jobs report, however, released on Friday (and described below), argues for a more aggressive pace of interest-rate creases.

Meanwhile, S&P 500 Index companies posted solid first-quarter earnings growth. On average, profits jumped 9.6% compared to a year ago, beating expectations by an average of 4.7%.4 But the prospect of a more hawkish Fed, coupled with surging energy prices, outweighed these earnings results, briefly pushing broad U.S. equity indexes into bear-market territory — a decline of 20% or more from a recent peak — just a few weeks ago. Driving the drop were more cautious guidance and lower earnings from several companies, major retailers especially. (Disappointing results from retailers tend to be particularly worrisome for markets, as consumers are the linchpin of the U.S. economy.) More broadly, a tight labor market may force some firms to beef up wages in order to attract and retain workers. Doing so would lead to smaller profit margins (if companies absorb those elevated costs) or higher prices for customers (if they don’t).

Despite such a challenging scenario, analysts continue to revise up their earnings expectations for both 2022 and 2023. The combination of optimistic profit forecasts and falling stock prices has lowered valuation metrics (such as the price/earnings, or P/E, ratio) since the beginning of the year. That makes stocks more attractive for long-term investors, even as we’re anticipating extended bouts of volatility over the next several quarters, fueled by a series of Fed rate hikes. U.S. stocks are sensitive to rising rates as they (1) increase borrowing costs for businesses, (2) boost the relative attractiveness of fixed income and (3) decrease the present value of future corporate cash flows.

A strong jobs report strengthens the case for further Fed tightening

The streak of solid U.S. nonfarm payroll growth continued in May, with employers adding 390,000 workers, easily outstripping forecasts.5 Encouragingly, the size of the labor force grew by a similar amount (330,000), contributing to an ultra-low 3.6% unemployment rate for the third consecutive month.6 New workers filling open jobs is close to a best-case scenario for the U.S. economy, and at 82.6%, the labor force participation rate among prime age workers (those aged 25-54) climbed to within 0.5% of its pre-pandemic high.7

Not all the jobs data was positive, though. For the broad workforce, average hourly earnings (AHE) growth fell short of expectations (+0.3%), and the year-over-year increase decelerated from 5.5% in April to 5.2%.8 For non-supervisory workers, the news was better. Last month, AHE increased 0.6%, while the pace over the past 12 months (+6.5%) barely ticked down.9

Looking at the preponderance of labor market data over the past several weeks, one can argue that the U.S. jobs market may no longer be tightening. But we’d have to squint pretty hard to see evidence that it’s actually loosening significantly:

  • Initial jobless claims remain quite low by historical standards even as they’ve been rising since March.10
  • Continuing claims — the number of people currently collecting unemployment insurance — have fallen like a stone in 2022 and hit a fresh bottom the week of May 21, a sign of how easy it is to find work.11
  • April’s JOLTS data showed that both the number of open positions and the rate at which private sector workers quit their jobs are starting to decline.12

Aside from monitoring the health of the U.S. jobs engine, paying close attention to measures of job security is also crucial. One barometer, consumer spending, isn’t necessarily tied to how people feel about the economy as a whole. However, it’s inextricably linked to their own job security. Those who believe they’re unlikely to be laid off are more inclined to lower their savings rate and possibly dip into available credit to finance their lifestyles. In contrast, a general sense that firms are not just freezing headcount but actively trimming it could contribute to slower spending, with predictably damaging consequences for the economy.

So how might the Federal Reserve view May’s employment data? For starters, Chair Jerome Powell and his associates would applaud the latest round of robust job creation. At the same time, they’d fret that ongoing evidence of persistent tightness in parts of the labor market (notably in the leisure and hospitality sectors) might fuel already white-hot inflation via higher wages. That may well give them the green light to carry out their aggressive hiking plans and perhaps accelerate them.

Even before last month’s employment numbers were released, taking a breather in the pace of rate increases didn’t seem to be on the Fed’s radar. Vice Chair Lael Brainard said as much, recently indicating that the Fed isn’t poised to pause from its current rate-hiking cycle anytime soon, especially if inflation continues to run well above the Fed’s 2% target. We’d welcome smaller (25 basis points, bps) hikes starting in September if inflation were to cool and financial conditions tighten sufficiently. As of now, though, we think another 50 bps increase is on tap when the Fed meets on June 15.

Sources:
  1. Factset, Marketwatch
  2. Federal Reserve via Haver
  3. Bloomberg
  4. Bloomberg
  5. Bloomberg
  6. Bloomberg, Bureau of Labor Statistics via Haver
  7. Bloomberg
  8. Bloomberg
  9. Bloomberg
  10. Bloomberg
  11. Bloomberg
  12. Bloomberg

This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.

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