Are stocks whistling past the jobs graveyard?

Brian Nick, Chief Investment Strategist, Nuveen

The last week’s market highlights:

U.S. equities rallied last week despite the release of dispiriting economic news, including another 3.2 million first-time unemployment claims, the stunning loss of 20.5 million jobs in April (bringing with it a post-World War Two high 14.7% unemployment rate) and the U.S. economy’s first contraction in service-sector activity since 2009.^1,2,3 The S&P 500 Index gained 3.5% for the week, lifting its return since bottoming on March 23 to a remarkable 31%.⁴ Fueling last week’s advance were several familiar catalysts: hopes for further Federal Reserve stimulus, optimism over a COVID-19 vaccine and the gradual reopening of state economies.

Europe’s STOXX 600 Index squeezed out a modest gain (+1.1% in euro terms) in spite of a report showing that the eurozone suffered its worst-ever month of economic activity in April.⁵ Instead of dwelling on the data, investors focused on plans for several countries, including Germany, Italy, Spain, Greece and Portugal, to relax lockdown restrictions.

U.S. Treasury markets refrained from such bullish behavior. The yield on the bellwether 10-year note finished the week at 0.69%—not far from its all-time low of 0.54%—reflecting continued concerns over the U.S. economy’s long-term growth prospects.⁶ Meanwhile, the yield on the 2-year Treasury note, which tends to track expectations for Fed policy, declined to a record-low 0.13% on May 7, as investors began to consider the possibility of the Fed’s cutting interest rates below zero. That’s an unlikely scenario while Chair Jerome Powell is at the helm, however. In March, Powell stated that “We do not see negative policy rates as likely to be an appropriate policy response here in the United States.”

In our view, April’s unemployment rate won’t fall significantly in the near term even as states reopen their economies. For one thing, millions of people are receiving unemployment benefits that exceed their former pay, discouraging their return to work. And while we think Congress will pass another substantial fiscal stimulus package (around $1 trillion) next month, we’re not anticipating a blanket extension of the $600 per week federal boost to state unemployment insurance, which expires in July.

With different states likely to be operating at very different capacities over the summer, a more refined and varied approach to addressing employment woes will be needed. For now, though, the labor market’s problem isn’t too little supply—it’s too little demand.

Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s Q2 Update:

U.S. economy: Looking for a relatively rapid recovery in the second half of 2020.
Global economy: Europe may begin to outperform the U.S. in Q3.
Policy watch: Fed to guide the economy even after the country reopens.
Fixed income: Stay defensive, stay diversified.
Equities: Focus on quality companies at reasonable valuations.
Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.

Quote of the week:

“Youth fades. Love droops. The leaves of friendship fall. A mother’s secret hope outlives them all.” ̶ Oliver Wendell Holmes

An April we’d like to forget

In many respects, April’s dire employment data (20.5 million jobs lost and a 14.7% unemployment rate) reaffirmed what we already knew: the U.S. economy was largely shut down last month, and businesses were forced into mass layoffs. It’s also not surprising that some of the underlying details of the latest payrolls report were equally grim:

The number of part-time workers who would prefer to be employed full-time nearly doubled, from 5.8 million in March to 10.9 million.⁷ Although not included in the headline (U-3 unemployment) rate, these underemployed individuals are counted in the U-6 rate, which soared from 8.7% in March to 22.8%.⁸ (The U-6 rate encompasses both unemployed workers looking for jobs and part-time employees seeking full-time work.)

The labor force participation rate slumped to a near 50-year low of 60.2%.⁹

Average hourly earnings growth, meanwhile, increased sharply, to 4.7% in April from 0.5% in March.¹⁰ Although that sounds like a positive, it actually reflects a disturbing trend: lower-wage earners—those most likely to experience financial stress—were disproportionately laid off last month. A potential consolation is that many of them could see their incomes nearly or completely replaced by the enhanced unemployment benefits offered by the CARES Act.

While sifting through the rubble of the employment wreckage, we did spot one bit of relative good news. More than 18 million of the 23+ million unemployed people (in total) reported themselves as furloughed, i.e., only temporarily laid off.¹¹ Workers who remain attached to their employer may be able to resume their responsibilities faster than new hires, who often require training. That will help the economy recover faster, as companies can be fairly confident they'll have experienced employees ready to return as soon as the doors re-open for business.

Breaking down the breakdown in correlations between oil prices and energy stocks

Because oil and gas companies dominate the broad energy sector, prices for crude oil and energy stocks tend to move in tandem. Rising oil prices lead to higher profit margins for “upstream” energy companies, for example, which scout out new sources of oil and gas and then drill wells to extract them. In contrast, falling oil prices hurt their bottom lines given their mostly fixed production costs.

Yet that oil/stock price correlation hasn’t held up recently. In April, the price of West Texas Intermediate (WTI) crude fell 8%, from $20.48/barrel to $18.84/barrel, while the S&P 500 Index energy sector soared 29.7%. And thus far in May, while WTI oil has climbed 31%, to $24.69/barrel, the energy sector has returned just 1.7%.¹²

What’s causing this disconnect? We believe it’s the drastic difference between investors’ short- and long-term views of oil prices.

The near-term outlook for oil prices is quite bearish, as reflected by oil futures contracts. (These contracts require traders to buy or sell the commodity at a specified price in the future.) Demand for oil has plummeted even as the U.S. begins to emerge from its near-total lockdown. On the supply side, the agreed-to cuts by OPEC and other major producers may not be sufficient to reduce the global oil glut. Adding to the state of flux: there’s very limited capacity in the U.S. to store the excess supplies of crude that have been building up.

These three factors sent the price of contracts requiring buyers to take delivery of oil in May from $18.31 on April 17 to -$37 on April 20, the day before the agreed-to contract terms were about to take effect.¹³ As a result, sellers were actually paying buyers to take oil off their hands rather than bear heavy storage costs. Although oil prices have since risen, we expect similar volatility as upcoming futures contracts approach their expiration dates.

In contrast, the longer-term view for energy stocks is far more optimistic, based on the price of equity futures contracts expiring in 2021. These contracts have exhibited much less volatility and currently reflect a roughly $10 per barrel increase in oil prices from today’s levels. Such a projected pickup gives investors more confidence in the bottom lines of energy companies down the road.

Energy stocks have also benefited from recent encouraging news about a possible COVID-19 vaccine, which would significantly hasten the economy’s recovery and spur demand for oil. In our view, such headline-driven rallies are likely to continue, potentially aiding the energy sector’s performance.

Sources:

Haver
BLS
ISM
Marketwatch, Haver
Bloomberg, IHS Markit
Haver
Bloomberg
Bloomberg
Haver
Haver
Bloomberg
Bloomberg
Haver

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.

These views are presented for informational purposes only and may change in response to changing economic and market conditions. This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy or sell securities, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor's objectives and circumstances and in consultation with his or her advisors. Certain products and services may not be available to all entities or persons. Past performance is not indicative of future results. Economic and market forecasts are subject to uncertainty and may change based on varying market conditions, political and economic developments.

All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Any investment in taxable fixed-income securities is subject to certain risks, including credit risk, interest-rate risk, foreign risk, and currency risk. There are specific risks associated with international investing, which include but are not limited to foreign company risk, adverse political risk, market risk, currency risk and correlation risk. In addition, investing in securities of developing countries involve greater risk than, or in addition to, investing in developed foreign countries.

The investment advisory services, strategies and expertise of TIAA Investments, a division of Nuveen, are provided by Teachers Advisors, LLC and TIAA-CREF Investment Management, LLC.

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