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“Goldilocks” jobs report will likely keep Fed on track
The last week’s market highlights:
Quote of the week:
“October is the fallen leaf, but it is also a wider horizon more clearly seen. It is the distant hills once more in sight, and the enduring constellations above them once again.” — Hal Borland
Each week, we present our featured topics in the context of the major themes listed below from the Nuveen Q4 Outlook:
- U.S. economy: Still running ahead of its peers.
- Global economy: Trade a bigger concern outside the U.S.
- Policy watch: Trade risks haven’t bitten the U.S. yet, but that may change.
- Fixed income: Continue to position for rising rates.
- Equities: The price is right outside the U.S.
- Asset allocation: Finding pockets of opportunity.
U.S. economy: The labor market is finally cutting workers some slack
October’s employment report was very strong, even after allowing for an inevitable catch-up from September’s Hurricane Florence-distorted reading. The addition of 250,000 nonfarm payrolls keeps the economy on a pace of 200,000 per month over the past year—an extraordinary number, considering the unemployment rate has already declined to 3.7%.That rate remained unchanged in October, but the underemployment, or “U6,” rate fell to 7.4%, back to its low for the cycle. The drop in U6 is correlated with higher wage growth. And higher wage growth, as measured by average hourly earnings (AHE), was certainly a highlight of the jobs report.
AHE, which have often failed to grow at a pace commensurate with job creation during this recovery, rose 3.1% year over year in October. This was the fastest pace in the current nine-year-plus expansion and the first time the rate has exceeded 3% since April 2009. It’s worth noting that AHE is just one indicator of earnings; the Employment Cost Index (ECI) for private-sector wages and salaries is arguably better but is reported only quarterly. Last week’s ECI release covering the third quarter showed that this measure, too, grew 3.1% over the past four quarters, a pace not seen since 2007.
Perhaps most encouragingly, labor force participation ticked up 0.2%, to 62.9%. That number hasn’t been above 63% since 2014, but the increase in October was due to prime-age workers on the sidelines moving back into the job market in greater numbers. This is an attractive scenario, as the additional workers may help to keep wages from rising too fast.
Stocks have been wary of good news lately, but the jump in AHE—though strong on a year-over-year basis—was a relatively modest 0.2% in the month of October. That, plus the rising labor force participation rate, makes this a “Goldilocks” employment report, one that brings good news but not necessarily accelerated Fed tightening. While growing wages are a positive for workers and a leading indicator for household spending, they also put at least moderate pressure on corporate profit margins. October showed us that concerns about margin sustainability can disturb equity markets, but rising wages are unlikely to result in runaway inflation anytime soon, if ever.
In bond markets, Treasury yields rose last week on the upside surprise in employment data. Going forward, further sensitivity to data releases and yield volatility are possible. Moreover, we expect the current pace and trajectory of Federal Reserve rate hikes to remain intact, barring an unexpected economic or market shock. The Fed wants to get to a neutral policy rate, which it currently defines as 3%, both to prevent the economy from overheating and to give enough leeway to cut rates in the next recession should conditions warrant.
Economic and market outlook: Rough sailing in October hasn’t altered our view
While October was marked by continuing trade concerns, rising interest rates and volatile equity markets that sent some major indexes briefly into correction territory, there was little in the way of fundamentals to shake our long-standing view that the U.S. (and global) economic expansion is ongoing and will continue through at least next year.
- Hiring remains strong, wages are growing, and businesses and consumers are reporting high degrees of confidence about current and future conditions. This is not an environment in which recessions or equity bear markets typically begin, so we are still judiciously “risk on” in our view of the investing landscape.
- Virtually all asset classes appear more attractively valued today than they did a month ago, from long-duration, high-quality bonds to emerging-market equities and everything in between.
- We don’t foresee a quick and easy bounce in U.S. stocks, but positive earnings growth and lower valuations are a good starting point from which stocks should start to recover.After October’s broad selloff, some investors may be tempted to move to ultra-defensive sectors of the equity market (or more dramatically, to cash). In our view, that would amount to “buying high”—not a sound investment strategy.
- After October’s broad selloff, some investors may be tempted to move to ultra-defensive sectors of the equity market (or more dramatically, to cash). In our view, that would amount to “buying high”—not a sound investment strategy.
- Treasury yields have risen but seem unlikely to break significantly above their early October highs. We expect the bellwether 10-year yield to remain in a range between 3.10% and 3.30% range for the duration of this year.
- Overseas, the investment story is more fraught, given geopolitical risks and slower growth relative to the U.S., but asset valuations—including currencies—reflect these concerns via high risk premiums compared to U.S. securities.
After the first 10 months of 2018 and given the outlook for the remainder of the year, investors may find it useful to rebalance their portfolios. On the other hand, the performance gap between stocks and bonds has been modest year to date, so rebalancing may not be necessary.