Are stocks whistling past the jobs graveyard?

Brian Nick

The last week’s market highlights:

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.
  1. Haver
  2. BLS
  3. ISM
  4. Marketwatch, Haver
  5. Bloomberg, IHS Markit
  6. Haver
  7. Bloomberg
  8. Bloomberg
  9. Haver
  10. Haver
  11. Bloomberg
  12. Bloomberg
  13. 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.
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