U.S. equities don’t appear to be “Fed” up after a strong jobs report

Brian Nick

The last week’s market highlights:

Quote of the week:

“The best thing about the Kentucky Derby is that it is only two minutes long. It is the quickest event in sports, except for sumo wrestling and Mike Tyson fights.” – Hunter Thompson
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2Q 2019 Outlook :
  • U.S. economy: Late cycle but no recession
  • Global economy: Slower this year than last  
  • Policy watch: A dovish turn for global central banks  
  • Fixed income: Rates likelier to rise than fall
  • Equities: Get defensive, stay invested
  • Asset allocation: Still favorable to emerging-market assets

Equities: There was a lot to like about April

For U.S. equity markets, the fourth quarter’s selloff seems like ancient history. The S&P 500 Index maintained its torrid 2019 pace with a 4.1% gain in April, a stellar start to the second quarter. That put the index up 18.3% over the first four months of the year—its best such stretch since 1987. Making this surge even sweeter for investors has been the equity market’s relatively smooth ride. Volatility, as measured by the VIX (or “fear index”), has been steadily declining, from a 10-month high of 36.1 on December 24 to 14.4 on May 2. (The VIX tends to fall when stocks rise and vice versa. It’s measured on a scale from 1-100, where 20-25 represents the historical average.)   
Relatively low volatility isn’t all that’s changed since the end of last year. Sectors that lagged in 2018 have turned into leaders in 2019. Cyclicals like information technology, industrials and consumer discretionary, all of which posted fourth-quarter losses in the 16% to 17% range, gained at least 20% through April 30 as recession fears faded. In contrast, defensive sectors such as utilities and health care, two of the fourth quarter’s top performers, have trailed the S&P 500 this year amid the market’s risk-on tone. Overall, heading into May, investors who’ve stayed invested likely recouped their year-end losses—and then some.
Driving April’s advance has been a relatively solid first-quarter earnings season, though it hasn’t kept pace with the blowout results from the second and third quarters of 2018. According to Bloomberg, of the 389 S&P 500 companies that have reported so far, 76% have topped earnings forecasts, by an average of 6.3%. At the same time, while sales have grown 4.6%, the average sales surprise has been just 0.2%.
This less robust corporate profits picture is to be expected, in our view. Last year’s record earnings were fueled by lower borrowing costs and tax cuts, whose benefits have largely faded. And in 2018, firms didn’t begin to consider the impact of tariffs until March, when the U.S. began its aggressively protectionist trade policy. Meanwhile, negative earnings revisions for future quarters continue, leading full-year 2019 consensus estimates to remain virtually unchanged since the start of the reporting season in early April.

U.S. economy: Even more to like about April

Another month, another upbeat employment report. After adding 189,000 jobs in March, the U.S. economy created 263,000 more in April, comfortably ahead of forecasts of around 210,000. Moreover, the unemployment rate fell from 3.8% to 3.6%, its lowest level since December 1969. Average hourly earnings for all employees rose a respectable 0.2% in April and 3.2% year over year.
If there was a weakness in the report, it was the broad labor force participation rate, which declined to 62.8%. Among prime-age workers (ages 25-54), it dropped to 82.2% from 82.5%.
Although markets and the media often focus on month-to-month changes in the labor market, we recommend taking a longer perspective that considers trends over 3- or 6-month time frames. Here’s what’s transpired since last November:
  • Unemployment fell slightly, from 3.8% to 3.6%.
  • The economy added 1.24 million jobs, an average of 207,000 per month—even with February’s meager total (56,000, upwardly revised).
  • Labor force participation edged down for the full population and for prime-age workers.
  • While earnings growth accelerated for rank-and-file employees, it slowed for supervisory workers.
In addition to the April payrolls report, there were several other strong data releases last week. Among them:
  • Consumer spending surged 0.9% in March, its best month since 2009.
  • U.S. worker productivity unexpectedly jumped to 3.6% in the first quarter and 2.4% from a year earlier, the fastest annual rate in almost nine years. Higher productivity allows an economy to grow faster without stoking inflation.
Less-positive data included the following:
  • According to Purchasing Managers’ Index (PMI) readings from the Institute for Supply Management, manufacturing and non-manufacturing activity declined in April, to 52.8 and 55.5, respectively. (Levels above 50 indicate expansion.)
  • Inflation remained subdued, with the core PCE Index, the Fed’s preferred inflation gauge, registering just 1.6% (year on year) in March, well below the Fed’s 2% target.    
Speaking of the Fed, how do we think Chair Jerome Powell and his colleagues will react to last week’s data releases?
Heading into the May 1 Fed meeting, markets were looking for clues that the Fed was considering lowering rates. Indeed, fed funds futures—used by traders to bet on the direction of interest rates—showed a nearly 70% chance of a rate cut by the end of the year. But after Powell said “transitory” factors may be keeping inflation subdued and downplayed concerns that stubbornly low inflation reflected broader economic weakness, that probability began to decline and stood at 50% (still high) on May 3.
We’re not convinced a rate cut is where the Fed is headed. Yes, the Fed’s first-quarter dovishness and moderating policy forecasts almost certainly suggest rates will stay put for now. In fact, we don’t expect the Fed to make any changes to rates in 2019. But given the U.S. economy’s solid performance and diminishing slack in the job market, we think there’s a better chance of a hike than a cut come December.
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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