Wentz Weekly: Strong Job Growth In May, Details Not As Good As Headline

Wentz Weekly Insights
Strong Job Growth In May, Details Not As Good As Headline

Stocks capped off the holiday shortened week with the third consecutive weekly gain and the sixth consecutive weekly gain for the NASDAQ which is heavy in growth and tech stocks. That has been the trend in 2023 as investors bet the Fed will cut interest rates sometime near the end of summer (growth stocks perform better when rates decline since most of their profits will be realized further in the future, and a lower interest rate makes those profits more valuable today).

Several things drove the rally this past week, which was mostly driven by Friday’s session and was more broad based than in recent weeks where the top ten names drove most of the gains.

The House passed the debt ceiling bill, the “Fiscal Responsibility Act” (see here for several details from last week’s newsletter) mid-week and the Senate passed it late Thursday night which helped fuel Friday’s rally. This removes a key uncertainty from the markets and avoids the chance of a government default, something that would have been disastrous for the markets. It seemed as if this was all we were hearing about in the media, so it is nice to get this out of the way.

The other things investors have been focused on is the Fed and digesting the rush of comments from Fed policymakers over the past several weeks. Many district bank Presidents have given a more hawkish tone in recent days, suggesting another interest rate increase would be necessary at the Fed’s June 14 meeting, pushing up the probability of a rate hike. Inflation remains too high and is not slowing fast enough which gives officials no reason to wait to raise rates again, according to several policymakers. However, about halfway through the week, Governor Philip Jefferson who is nominated to be Vice Chair, the second in line to Chairman Powell, supporting a no hike at the next meeting, saying inflation has come down substantially.

The odds of an interest rate increase at the June meeting began the week near 70%, but after the comments last Wednesday from Jefferson the odds moved down to roughly 25%. In addition, there was an article from WSJ’s Fed correspondent Nick Timiraos, who tends to have the inside scoop at the Fed, explaining how the Fed is setting up for a June pause. The strategy of skipping a meeting would give the Fed more time to assess the impact of the already 5% increase in rates over the past 15 months.

Finally, adding to the momentum on Friday was another strong labor report. The Department of Labor said 339,000 jobs were added to the economy in May, well above the expectation of 190,000 new jobs. The US has averaged 314,000 jobs through the first five months of 2023, only 85k less than 2022’s monthly average, despite what is seen as a slowing economy. In addition, wage growth remains in check. The average wage rose 0.3% in May and is 4.3% higher over the past year. There were worries if wage growth remained high, it would lead to further inflation in services.

However, we are skeptical of any sustained rally for multiple reasons. With the labor report, you would be misled if you were to read only the headlines. The establishment survey is what produces the headline number of 339,000 job gains, which is good as the gains were widespread and seen through all sectors of the economy. But the household survey, which includes small businesses, showed the number of people employed declined 310,000 while the number unemployed increased 440,000 to 6.097 million and the highest number of unemployed people since February 2022. This caused the unemployment rate to increase to 3.7% from 3.4%. And while wage growth is solid at a 4.3% annual increase, if you account for inflation wages are not keeping up. Subtracting the 4.9% estimated annual rate of inflation in May, workers purchasing power is being reduced 0.6%.

The divergence between the establishment survey and the household survey in May is the widest we have seen since the early days of the pandemic and leaves more questions on what is actually happening in the labor market.

Regarding the Fed, even though the expectation has moved to no rate increase in June, there is wide support for further rate increases and comments from Jefferson indicated the Fed will be prepared to raise rates further later this summer, which was repeated in the WSJ article. Jefferson said even though the Fed may skip June’s meeting, it does not mean it has reached peak rates. The fact is inflation does remain uncomfortably high for policymakers and this would mean more rate hikes which will cause more growth concerns for investors. While the odds of a June rate hike have moved down, the odds of a July rate hike have moved to over 65%.

Finally, the debt ceiling passage may actually tighten liquidity in the markets. As the government ran into the debt limit its excess liquidity went into the financial system and helped the equity rally this year. The passage of the debt ceiling bill will reverse this with the Treasury needing to rebuild its general account by selling more short term bonds, in effect reducing liquidity in the markets.

Markets are also moving into a historically weak period of the year. The average return for the S&P 500 for the month of June is -0.11% going back to 1960. This ranks 11th out of all months, only behind September. We are not calling for the markets to crash, we are just mindful of how quickly stocks have risen and all signs are leading to another pullback.

Week in Review:

Stocks opened the week Tuesday after the holiday weekend with little action. The big news was President Biden and Republicans reaching a deal on raising the debt ceiling and avoiding default. Data included the Case Shiller home price index that showed another monthly increase in home prices after seven consecutive monthly declines and consumer confidence that fell due to falling expectations on the economy. Semiconductors, driven by Nvidia, continued their rally and were the best performers on the day while the major stock indices were mixed with the S&P 500 unchanged.

Investors continued to focus on the progress of the debt ceiling bill Wednesday, with the House passing it later in the day. Data included another increase in job openings. Meanwhile, in the morning, Cleveland Fed President Loretta Mester supported another rate increase at the next meeting saying she saw no “compelling reason” to wait to raise rates again, but later in the day Fed Governor Jefferson said he supports a pause and said if the Fed skips a meeting (does not raise rates) it does not mean it is finished raising rates and more hikes could follow the skipped meeting. Markets were at the lows of the day then recovered from these lows after Jefferson’s comments while the probability of a rate hike was cut in half to 25%. Energy was worst performer as oil fell another 2% to below $70 for the lowest levels since March, with the worst monthly performance in May since November 2021, while the S&P 500 fell 0.61% and short term Treasury yields fell 10 basis points.

Thursday saw more labor market data with the number of jobless claims unchanged and ADP’s payroll report showed more job gains than expected, while manufacturing survey indexes remained in contraction territory signaling recessionary conditions. There was again more attention on the Fed with Jefferson’s speech on Wednesday and an article by WSJ’s Fed correspondent Nick Timiraos suggesting the Fed would skip a rate hike at the June meeting. Data later in the morning showed another contraction in manufacturing activity in May, which has remained weak for a year now. Stocks ended up having a positive day over dovish views on the Fed with Treasury yields falling and the S&P 500 rising 0.99%.

Friday started positive after the Senate passed the debt ceiling bill overnight and the DOL’s employment report showed job gains were higher than expected for the 13th consecutive month with 339,000 new jobs. Although that would likely mean more rate hikes due to a tighter labor market, average earnings were stable and continue to come down on year-over-year comparison which helped move stocks higher. There were several earnings reports that were better than expectations, from technology with Broadcom and MongoDB to retail with Lululemon. It was a massive risk-on day with the employment report adding to the momentum with very strong breadth. The S&P 500 was up 1.45% while small caps outperformed with the Russell 2000 up 3.56%.

Stocks moved higher last week as the government avoided a default and markets saw a reset of expectations for a June rate increase while employment was mixed. All US indices were higher with strength continuing in tech after the Nvidia driven chip rally. The S&P 500 saw its third consecutive weekly increase while the NASDAQ saw its sixth, the longest since January 2020. The major US indices finished as follows: Russell 2000 +3.26%, NASDAQ +2.04%, Dow +2.02%, and S&P 500 +1.83%. Treasuries were mostly higher for the week after investors reset rate hike expectations for June, with the 2-year yield falling 5 basis points and the 10-year falling 13 basis points to 3.70%. The dollar was down slightly, breaking a three week winning streak, while oil fell 1.3% before the OPEC+ meeting Sunday.

Recent Economic Data

• Home prices in the U.S. rose 0.4% in March, higher than the slight decline that was expected and increasing for the second consecutive month after seven straight months of declines. Over the past year, home prices have increased just 0.7% after seeing record high price growth this time last year. With the April increase, home prices are only 3.6% below the peak in June 2022. Prices rose in all 20 major cities but there remains “stark regional differences.” Miami experienced a 7.7% annual increase making it the best performing city for the eight month in a row while Tampa, up 4.8% was right behind. In contrast, the West continues to see larges declines with Seattle and San Francisco prices down 12.4% and 11.2% respectively. Prices in the Southeast are up 5.4% on average and remain the hottest region while the West is down 6.2%. Cleveland in the middle at a 2.0% annual increase.

• The Conference Board’s consumer confidence survey index ticked lower in May to an index level of 102.3, down 1.4 from April levels. The present situations index fell 3 points to 148.6 while the expectations index fell slightly to 71.5 and remains below 80 (a level associated with recessions) for 14 of the past 15 months. The biggest change in the survey was a deterioration in consumers’ assessment of current employment conditions.

• The US Purchasers Manufacturing Index was 48.4 in May, dropping back into contraction territory from the 50.2 in April and the worst since February. The decline was driven by a deterioration in new orders as demand remained muted. Manufacturers continue their efforts to reduce inventories, which weakened purchasing activity and is expected to weaken production in the coming months. A big positive, input costs for manufacturers fell for the first time since May 2020, however selling prices continue to rise.

• The ISM manufacturing index was 46.9, falling deeper into contraction from 47.1 in April. The report noted there is additional uncertainty with demand easing again as new orders contracted at a faster rate with customers saying inventories are “too high” which is another negative for future production. Also, the backlog of orders fell to the lowest levels since the Financial Crisis of 2008-2009.

• Construction spending in April increased much more than expected with a 1.2% increase in the month driven by a 1.9% increase in spending on nonresidential as well as a 0.4% increase in residential. Compared to a year ago spending is up 7.2%, which is all coming from nonresidential spending which is up 25.3% over the past year and offset by a 9.1% decline in residential.

• The number of job openings as of the last day in April rose to 10.1 million, up 358k compared to March’s 2-year low and was above expectations of 9.6 million but are still below the 12-month high of 11.234 million in December and below the all-time high of 12.027 million March 2022. Pre-pandemic, job openings were averaging around 7.2 million. The number of separations fell 286k to 5.7 million while quits were little changed at 3.8 million, still historically high reflecting workers ability and confidence to find a better or higher paying job.

• ADP’s employment report for May showed 278,000 payrolls were added in the month, well above the expectation of 160,000 and continuing the streak of higher payroll growth than expected. Payroll growth was seen across all business sizes beside large businesses, which saw a 106k decline. ADP’s chief economist Nela Richardson said we are beginning to see decline in pay growth for job changers, something that would be a welcoming sign to the Fed.

• The number of jobless claims for the week ended May 27 were 232,000, up slightly from the prior week with the four-week average at 229,500. The number of continuing claims increased 6k to 1.795 million, which has leveled out over the past two months after increasing from 1.300 million since September, with the four-week average at 1.797 million.

• The jobs report beat expectations for the 13^th consecutive month, with payroll gains of 339,000 which was 149,000 more than expected and the best since January’s 472k increase, according to the DOL’s establishment survey. In the first five months of 2023 job growth has averaged 314k, still very strong and down from 2022’s average of 399k. Gains were seen in all sectors for May. However, the household survey showed the number of people employed declined 310k while the number unemployed increased 440k to 6.097 million for the highest level since February 2022. This resulted in an increase to the unemployment rate to 3.7% and the underemployment rate (the U-6 number) to 6.7%. The labor force increased 130k, keeping the labor force participation rate at 62.6%. The average wage increased 0.3%, slowing from the 0.4% increase in April and in line with the average monthly increase of 2023, down from 2022’s 0.4% average increase. Over the past year, average earnings are up 4.3%, decelerating from 4.4% in April and down from the peak of 5.9% March 2022.

• The average 30-year prime mortgage rate increased 22 basis points last week to 6.79% for the highest since the beginning of November when it reached a cycle high of 7.08%. Rates moved lower from there to 6.09% in February which was the lowest so far this year.

Company News

• Micron was down last week after presenting at a Goldman conference. It said current quarter trends in its business have been consistent with what it outlined in its most recent earnings call, with volumes and prices consistent with its expectations. With the China decision to ban its products, it has been a little over a week and with the additional discussions it has had since then, it believes the impact will be at the high end of its previously announced range (an impact to revenues by a low to high single digit percentage range), but the China ban is still very vague and unclear, which is what is causing the move lower.

• American Airlines updated its current quarter guidance to a new forecasted EPS range of $1.45-$1.65 (from $1.20-$1.40) due to better margins (an improvement of 1.5%) mostly from lower fuel costs. However, it only reaffirmed its full year guidance.

• Twilio was higher last week after reports activist investor Legion Partners has met with the company and is pushing for changes including board changes and divestitures.

• Boeing CEO Dave Calhoun said supply chain problems are going to prevent Boeing and other airplane manufacturers from keeping up with demand that has surged from airlines over the past several years. Despite this, the company says it will still be able to meet production targets.

• A Bloomberg report says Amazon is in discussion with wireless carriers to offer a no cost mobile phone service for its Prime members, or at a low cost like $10/month. Amazon later came out and said it currently has no plans to add wireless as a Prime benefit but is exploring adding more benefits for Prime members.

Other News

• OPEC+ (the Organization of the Petroleum Exporting Countries) met over the weekend to discuss productions levels for the next several months from the oil producing countries. The cartel decided to make no changes to the previously announced oil production cuts for this year, as was expected, and decided to extend the production cuts to the end of 2024. The group has 3.66 million barrels per day (bbl/day) of production cuts in place which includes 2 million bbl/day cuts from last year that continue into this year and another 1.66 million bbl/day in voluntary cuts agreed to several weeks ago in a surprise decision. Furthermore, production leader Saudi Arabia said it would make additional voluntary cuts of 1 million bbl/day, bringing its production to 9 million bbl/day. Global oil demand is near 100 million bbl/day. After the production announcement, oil was up about 10% before retreating. Oil has fallen consistently since the beginning of the year over demand concerns over a global economic slowdown.

• Federal Reserve updates:
• Cleveland Fed President Loretta Mester said she saw no “compelling reason” to wait before going forward with another rate increase.
• Philly Fed President Harker said the Fed should “skip, not pause” rate increases at the June 14 meeting. He said policy is close if not already at the point of being restrictive. He prefers to skip this meeting, depending on data over the next week and use that as time to assess how conditions develop before possibly raising rates again at the next meeting.
• New Fed Governor Philip Jefferson, and Vice Chair nominee, said if Fed makes the decision to do nothing at a meeting it “should not be interpreted to mean that we have reached the peak rate for this cycle.” He expects slower growth but does not expect a recession and inflation has come down substantially but it is still too high. He expects tighter credit conditions but uncertain on the impact to the economy.
• In an essay released by St Louis Fed President Bullard last week, Bullard said that by using the Taylor Rule rates are now at the “low end of what is arguably sufficiently restrictive given” economic conditions, but the “restrictive range” is from 5% to about 6.75%.

WFG News

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