The Weekend Edition # 125 - Is the US Labor Market easing?

Welcome to another issue of the Weekend Edition!

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Here's what we cover

• Market Recap - Mixed Week

• Macro - Signs of Easing in the Labor Market?

• Earnings - Corporate Profits to remain strong

• Closing Thoughts - Pace of Cuts

• Calendars

Market Recap - Mixed Week

March 11 - March 16, 2024

Nothing seems to deter US Markets. We set another record for the S&P 500 with an all-time high/ But it was certainly a confusing macro-heavy week.

We saw a divergence with the Nasdaq seeing more weakness than the S&P 500 or the Russell 2000 small-cap index. Overall, other than the small caps, all the major indices closed lower on the week.

We had Fed Chair Powell deliver his testimony to Congress and while he started with a neutral statement, he did re-affirm that rate cuts were coming this year.

With the last inflation report coming in stronger than expected, there are concerns that an early rate cut could spark off another round of inflation, particularly because inflation has not been completely contained. From what we see, the main deceleration in inflation has come from lower spending in goods due to the easing of supply chain issues and from lower gasoline prices. But, services spending not only have remained high, but we also continue to see a mild acceleration in many areas. This is the troubling sticky inflation that the Fed is worried about.

It shouldn’t come as a surprise that a rate cut could definitely start a new credit cycle and many companies that have been waiting to deploy capital have started to firm up plans. With employment still remaining considerably strong, and positive real GDP growth, that could mean another boom cycle and inflation.

A cut in the Federal Funds Rate has almost always seen a resurgence in Year-on-Year Inflation.

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Macro - Signs of Easing in the Labor Market?

The US Jobs Report had a number of surprises this week. To recap, these were the estimates:

In February, the number of jobs increased by 275,000, although there were downward revisions for the figures reported in previous months.

“The change in total nonfarm payroll employment for December was revised down by 43,000, from +333,000 to +290,000, and the change for January was revised down by 124,000, from +353,000 to +229,000. With these revisions, employment in December and January combined is 167,000 lower than previously reported.”

Over the past six months, the average job growth rate has been 231,000 per month. Despite this growth, the unemployment rate unexpectedly increased by 0.2 percentage points to 3.9%. This rise in unemployment is attributed to a weaker performance in the household survey of employment, which has lagged behind the establishment survey's measures in recent times.

Moreover, the increase in average hourly earnings was modest at just 0.14% for February. This slight rise is thought to be a correction from an unusually high increase in January, which was likely influenced by weather-related factors. However, looking at a broader timeframe, average hourly earnings have grown by 4% on a three-month annualized basis, indicating an overall upward trend in wages despite the recent modest increase.

Earlier in the week, we saw US Job openings decrease by 26k. JOLTS job openings 8,863k for January vs. median forecast 8,850k, prior revised 8,889k. The level is still far too high and keeps the labor market tight. But we are seeing other signs of easing.

The Quits Rate has now dropped to 2.1%, lower than pre-pandemic levels. We had a lot of people quit during the pandemic because of the wealth effect, fear, and home-care. But, now we’re seeing the rate drop which signifies that the labor market is gradually easing as more people want to keep their jobs.

Finally, Challenger Job Cuts are also beginning to rise, particularly in the tech sector.

The data still remains mixed. There are signs of softening when it comes to the quits rate and job cuts but, overall job creation still remains relatively strong. What we can tell from all the data when taken together is that the labor market is definitely coming back into better balance, i.e., Demand and Supply are gradually getting closer to equalizing.

Earnings - Corporate Profits to remain strong

For Q4, 2023, FactSet reports an overall earnings and revenue growth for the S&P 500 of 4.1% YoY.

As companies become more cautious about future earnings, the number raising EPS guidance has dipped below historical norms, indicating a potentially more challenging investment landscape ahead. However, Big Tech continues to see upward earnings revisions.

While earnings may be revised upwards, we expect earnings in general to slow for Big Tech as the boost from AI and other themes start to broaden out and the rest of the market plays catch up with Fed rates cuts on the horizon.

In 2024, nonfinancial corporate profit margins are anticipated to remain robust, despite experiencing a slight dip from a 17% peak of the sector's GDP in 2022 to an average of 16% in 2023, which still towers over the 13% figure seen in the final quarter of 2019.

This enduring strength is attributed to a combination of reduced costs for intermediate inputs and a deceleration in wage growth. However, these positive factors are somewhat counterbalanced by the diminishing impact of previous scarcity and an uptick in corporate interest expenses.

Despite these pressures, an uptick in overall nonfinancial profit margins to approximately 16.3% is expected this year. This high margin environment is likely to coexist with a trend of disinflation, supported by declining costs for inputs and labor, alongside reduced scarcity effects, which collectively contribute to the downward pressure on inflation in 2024.

Closing Thoughts - Pace of Cuts

Historically, central banks in major economies often start lowering interest rates by making three quick cuts in a row in past soft landings, according to GS. They usually speed up these cuts if inflation is low, economic growth slows down, or if interest rates are much higher than what is considered normal. One key sign they look for to speed up rate cuts is if more people start losing their jobs.

Given this pattern, it's expected that the central banks in the US, Europe, the UK, and Canada will begin by cutting rates three times quickly. But after these initial cuts, Europe might reduce its rates faster than the others.

The Fed definitely doesn’t want to have to start hiking again once they cut, so we could be looking at a situation where they delay cuts because we’re still not out of the woods with inflation.

We have the CPI inflation numbers for the US on Tuesday next week, and we’ll be watching to see if a re-acceleration trend has begun.

Have a great week ahead!

Sincerely yours,

Ayesha Tariq, CFA

There’s always a story behind the numbers.

Calendars

US Earnings

US Economic Calendar in Eastern Time (Source: Trading Economics)

None of the above is Investment Advice. I may or may not have positions in any of the stocks or asset classes mentioned. I have no affiliation with any of the companies other than explicitly mentioned.