It’s Gonna Be May(be)

Feb 5, 2024

By Ben Norris, CFA, Senior Investment Strategist, Vice President
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The U.S. labor picture continued to be confounding last week as data provided both positive and negative views. While Federal Reserve (Fed) chairman Jerome Powell has consistently referenced a strong labor market as a sign that Fed policy hasn’t gotten too tight, there are emerging signs that the labor market is poised to weaken further in the coming quarters. Nonfarm payrolls increased by more than 350,000 in January, which was the largest gain in a year and well ahead of expectations. Job gains for November and December were revised higher as well while each of the major employment categories (education & health, professional & business, retail, government, and manufacturing) all saw gains. The unemployment rate remained stable at 3.7% (near its 50-year low), highlighting the overall resilience of the U.S. labor market. Last week’s employment data also saw a 4.5% rise in hourly earnings versus a year ago, which is encouraging for workers but a sign that the Fed has more work to do in combating inflation.

Despite these points, total hours worked are up just 0.3% from a year ago, and hours haven’t been this low since March 2020. So, while hiring and wages have been solid, employers are finding less and less for their employees to do. This helps reconcile what appears to be an otherwise strong labor market with seemingly daily layoffs from major companies, especially those in the Technology sector. The most obvious explanation here is that companies who over-hired during the pandemic are now working to right-size their headcounts for a normalized economy with tightening financial conditions. Companies such as Google, Amazon, eBay, UPS, Spotify and Meta (formerly Facebook) have all announced sizeable layoffs in recent weeks. Similarly, manufacturing productivity rose 2.3% in the fourth quarter, which is less positive than it sounds considering both output and hours worked declined. However, math is math, and because hours fell at a faster rate than output, productivity technically gained. I do believe that the labor market is showing signs of cooling; however, most high-profile layoffs are probably more of an indicator of poor hiring practices than strategic preparations for a weaker economy.

Despite my beliefs about the labor market, the only opinion that really matters is the Fed’s. Last week, the Fed held its two-day policy meeting that concluded with a Wednesday afternoon press conference where Chairman Powell once again disappointed investors by putting off the start of interest rate cuts. In 2023, the expectation was that the Fed would begin cutting rates in early 2024 and keep an aggressive pace of cuts through the end of the year. All the while, Powell and other Fed policy makers have done their best to push back on that notion, indicating that there could be some policy easing in 2024, but it would be later in the year, less aggressive than investors were pushing for, and above all it would be dependent on inflation and labor data. To be fair to investors, the Fed does not have a great track record when it comes to mapping out policy, so it is a bit surprising that the economy has been so resilient following a series of rate hikes that were historic in both speed and magnitude. In its most recent statement, the Fed indicated that it “does not expect it will be appropriate to reduce the target range (of interest rates) until it has gained greater confidence that inflation is moving sustainably toward 2%.” The statement also highlighted that the balance of risks between inflation and employment is as important as ever. So, while we’ve established that the labor market is slowly cooling, inflation is still too high for the Fed’s liking at current levels.

The Consumer Price Index (CPI) rose 3.4% in 2023 compared to 6.5% in 2022, and more recent readings have shown that the annualized increase over shorter time periods is nearing the Fed’s 2.0% goal. Similarly, the Personal Consumption Expenditures (PCE) price index, which is the Fed’s preferred measure of inflation, recently dipped below 3.0% year-over-year for the first time since March 2021 after peaking above 7% in June 2022. Progress on inflation has been encouraging, but there is still work to be done. Measures of “core” inflation, which remove the impact of more volatile food and energy prices, are still too high. The energy component of CPI declined 2.0% in 2023 and played a significant role in the headline reading’s trend lower. Core CPI and Core PCE increased at 3.9% and 2.9%, respectively, in their latest readings, well above where the Fed wants things to be. I worry that we are a geopolitical event away from rising energy prices, which would in turn create another hurdle for inflation. Still, the Fed appears to be increasingly confident that the data is trending in the right direction, which would clear the way for the rate-cutting process to begin sometime this year.

Many investors believed that the Fed’s March policy meeting would see the beginning of cuts, but Chair Powell made it clear that March is still too soon based on current data. That leaves the Fed’s May policy meeting as the next most likely culprit in investors’ minds. The CME Group’s FedWatch Tool currently shows a 60% probability of a 0.25% rate cut in May. I’m not so sure investors will get their wish, considering employment and inflation data that is trending well but still not where the Fed wants and the fact that economy doesn’t appear it needs lower rates to continue expanding. U.S. Gross Domestic Product (GDP) not only grew in 2023, but accelerated to a 2.5% annualized pace, up from 1.9% in 2022. The fourth-quarter reading of GDP grew at a 3.3% annualized pace, ahead of 2.0% consensus expectations. Strong consumer spending was the largest contributor to growth, but each component saw positive contribution. Core GDP, which notably excludes government spending was up 2.6% in the fourth quarter and 2.7% in 2023. Strong growth trends have carried over into the new year with the Atlanta Fed’s GDPNow model estimating 4.2% growth for the first quarter of 2024, which would be impressive to say the least. Under current conditions I don’t see a reason for Chair Powell and his friends at the Fed to think about cutting rates. An accelerating economy paired with easing inflationary pressure and a relatively stable labor market provides clear cover for the Fed to keep rates higher for longer. The Fed cuts rates in response to recessionary indicators, and we just aren’t there yet. Unfortunately for bullish investors, I don’t think it’s going be May for the first rate cut.

The fourth-quarter 2023 earnings season is nearly half over, and results have been mixed so far. The dominant narrative in 2023 was the “Magnificent Seven” absolutely spanking the other 493 S&P 500 companies on a total return basis. The group of seven companies returned over 100% on average in 2023 on strong earnings and revenue growth. The market did broaden in the fourth quarter with smaller, value-oriented stocks holding their own into the end of the year, a development which had investors feeling optimistic about a sustained rally powered by 2023 laggards. This trend has quickly reversed in 2024 with mega-cap growth stocks once again leading the market higher. Year-to-date large cap growth stocks are up more than 6% while small- and mid-cap value stocks have fallen into negative territory. Market strategists have noted that the Magnificent Seven trade at a significantly higher valuation that the rest of the market, but an examination of growth expectations can help rationalize the premium. Consensus estimates expect the seven companies to grow sales at 12% annualized for the next three years versus 3% for the rest of the S&P 500, offering support for continued outperformance and an ongoing valuation premium.

This week’s economic calendar is relatively quiet with Fed policy makers giving speeches throughout the week where investors will look for clues for future policy moves. Friday will see the announcement of seasonal revisions to CPI for the last five years; this may have an impact on recent CPI data. Finally, the fourth quarter 2023 earnings season will continue with industry bellwethers such as Caterpillar, McDonalds and Tyson Foods reporting results.

9:45 AM U.S. Services PMI Jan. 52.9
10:00 AM ISM Services Jan. 52.0 50.6
8:30 AM Various Federal Reserve Speakers
8:30 AM U.S. Trade Deficit Dec. $62.1B $63.2B
3:00 PM Consumer Credit Jan. $15B $23.7B
8:30 AM Initial jobless claims Feb. 3 220,000 224,000
8:30 AM Consumer Price Index (CPI) Factor Revisions


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