Market Digests Fed, Jobs, and Earnings
What happened last week?
- The S&P 500 gained 1.6%
- The Dow Jones index fell -0.2%
- The Nasdaq composite advanced 3.3%
- Investors digested earnings releases, a 25bps rate increase by the Fed
- Surprisingly strong jobs report showing 517K jobs created in January alongside a 53-year low 3.4% unemployment rate
The recent stock market melt-up has been led by 2022's laggards. In the economy, trade, manufacturing, and construction have already retreated, and the jobs report leaves the Fed positioned to raise rates again next month. What's more, the economy hasn't yet felt the full impact of the monetary tightening already implemented.
3 Things to Know
Looks like an employment boom
The January US employment report showed 517,000 new jobs added, the strongest employment gain since July of 2022. We thought the January gain would be large and positive, but nothing of this magnitude.
Both January and June see the largest seasonal swings in actual employment in the United States. Therefore, these two months require the largest “seasonal adjustments” to “normalize” the data. The intent of adjustments is to remove large seasonal impacts from temporary employment; think retail hires in December and summer hires at vacation resorts.
But what does this mean in simple terms? The January 2023 employment report anticipated a 3 million drop in unadjusted (i.e., real) employment, but the actual drop in employment was 2.5 million, creating the 517,000 gain in jobs “after adjustments.” In other words, actual employment fell by much less than expected. That's the “good news.”
But read the fine print. Government seasonal adjustments are dramatic and the process of making them is complex and subject to future revisions.
We expect this huge “employment gain” to set back the recent rally in financial assets and strengthen the US dollar. For the Fed, it will provide support for additional rate hikes, but is unlikely to provide a sustainable rationale for a return to more rapid tightening.
Contradictory data leaves markets unsettled
For investors, the huge employment report does cast doubt on other data. Seasonal adjustments and seasonal data should leave us somewhat skeptical about the economy's true performance until more and better information comes into view later this spring.
That makes our job - to predict the path of the economy and markets - harder. There have been many signs of weakness in the US economy. In particular, the cyclical parts of the US economy - manufacturing, trade and residential construction - are all contracting. This is in sharp contrast to January's employment data.
Unfortunately, we believe the impact of the “rapid” monetary tightening of 2022 has not yet been fully felt throughout the economy. The January job surge is out of line with forward-looking fundamentals, and we believe weaker hiring data is likely in the coming months. But it's also possible that the resilience of the economy has been underappreciated.
Looking for signs of a bottom
Historical precedent is clear: Don't wait for a weak economy to strengthen before changing your asset allocation to position for growth. This is because markets lead the economy in both directions.
What we are looking for are signs pointing to the finale for the weakening of the economy. While the January employment report suggested otherwise, in our view, the preponderance of data still suggests sidelined investors won't have to wait long before the weakest readings for the US economy are in sight around mid-year 2023.
If the pace of the decline in US manufacturing orders over the last 12 months continues, it would rival the Covid collapse and 2008/2009 bust. We see this as unlikely.
Unlike those periods, neither a forced shutdown of economies nor a systemic banking sector collapse is on the horizon.