Wentz Weekly Insights
Another Strong Jobs Report But More Warnings From Executives
With the recent comments from some prominent figures, it may feel like we are on path to talking ourselves into a slowdown and eventual recession. Recently, JP Morgan CEO Jamie Dimon described the challenges to the economy as similar to a hurricane, Tesla’s Elon Musk said he has a “super bad feeling” about the economy and needs to stop hiring, Goldman Sachs COO said the economic turmoil is one of the most challenging he has ever faced, and RH CEO said the next several quarters pose a challenge and demand continues to slow.
However, companies have continued to post strong results (while we do not dismiss the fact costs are rising at a faster pace) and recent economic data has shown us economic conditions remain strong and continue to expand, albeit at a slower pace than 2021. The labor market is what continues to drive the economy forward and May’s employment report shows that hiring continues and that no recession is in sight this year.
The Department of Labor reported Friday that improvement in the labor market continued in May with payroll growth of 390,000, about 70k above expectations. Some strategists are calling it a “goldilocks” report – it was not too good to where the Fed needs to tighten policy more aggressively but was not too low where it would increase the concerns the economy is slowing more than expected and heading into a recession. Job gains were widespread – the most gains were seen in leisure and hospitality, manufacturing, and business services. This is consistent with the view consumers have shifted spending to services after an extended period of spending on goods, particularly large items, that was driven by massive stimulus payments.
Despite the strong gains made in the labor market over the past two years, it is still not fully recovered from pre-pandemic levels but should be there within the next several months. The number of nonfarm payrolls is still 822,000 below those levels, the number of Americans unemployed is now just 163,000 below pre-pandemic levels while the number of Americans either employed or looking for work (the labor force) is just 170,000 below pre-pandemic levels, leading to a labor force participation rate of 62.3% and still a full percentage point below the high in February 2020.
Another important detail of the report is the employment-to-population ratio of the important prime-age cohort (age 25-54) increased 0.1% to 80.0% and much closer to its pre-pandemic level of 80.5% after reaching a low of 69.6% in April 2020. Something that will continue to drive strong job gains is the 11.4 million jobs still available, which has remained near record-high levels all year. Americans are feeling comfortable switching jobs, looking for a better job or higher paying job, as the quits rate also remains near record highs with 4.4 million Americans quitting in the month. In addition, employers do not want to lay off anyone as the number of layoffs or discharges was a record low of 1.2 million in the month.
The average wage rose 0.3%, not as much as the 0.4% expected, but is still up 5.2% from a year ago. If there is a negative in the report, it is that workers are earning more but their earnings are still not keeping up with inflation. With inflation expected to be 8.2% y/y in May, real wages (inflation-adjusted) are down 3.0% over the past year.
What we need to remember is there are many concerns the market has right now and that is going to lead to continued volatility until investors have more certainty around these issues. However, what data is telling us right now is the economy remains strong, although slowing from its 2021 pace, supported by a very strong labor market. The Fed is dealt with the task of addressing the number one issue of inflation while keeping the economy growing. The probability of a recession has gone up, but data tells us it will likely not happen this year. Now the focus will be on Friday’s consumer price index inflation report.
Week in Review:
U.S. stocks opened Tuesday after the holiday weekend lower, recovered and briefly moved positive before ending in the red. Economic data in the morning showed home prices accelerated again in April with the average home price up 20.6% from a year prior, and consumer confidence that declined but was slightly better than expected. A hawkish tone came back in play after Fed Governor Waller said he supports 50 basis point rate increases for several more meetings and the policy rate should be above neutral by year-end to weaken demand. Oil moved lower after reports OPEC is considering suspending Russia from its production agreement, which would allow other members to increase production. The S&P 500 finished 0.67% lower for the day.
Positive news out of China on the official reopening of Shanghai sent optimism around global markets, with US stocks opening higher and growth/tech names helped by a strong quarterly report from Salesforce.com. On the economic calendar, manufacturing indices were mixed with the PMI showing slowing activity but ISM showing much stronger activity while job openings remain near record-high levels. The yield curve flattened with the 10-year moving back near 3% at 2.94% while stocks ended up moving lower after the open but finished off the lows of the day. The S&P 500 finished down 0.75% with energy the only positive sector (+1.8%).
Stocks were looking to open higher on Thursday until minutes before the opening bell Microsoft issues an update to its forecast, lowering expectations due to foreign exchange headwinds from the stronger dollar. OPEC held its monthly meeting, agreeing to increase the size of its production to 648,000 barrels per day for the next two months, nearly 50% higher than its previous quotas. At the same time, Saudi Arabia is indicating it is prepared to boost production to offset reduced Russian output. By around mid-day, stocks turned positive and were able to continue upward momentum with the S&P 500 closing 1.84% higher.
A number of headlines heading into Friday led to a lower market open in the morning. The biggest headline was Tesla CEO Musk writing in an email to Tesla executives he has a “super bad feeling” about the economy and Tesla would stop hiring and look to cut 10% of its workforce. Then home furnishing retailer RH warned demand trends were softening, which began after the invasion of Ukraine but softened further with the market decline. In addition, Fed Governor Brainard pushed back on a pause in raising rates in the fall saying it is hard to see a case for pausing. A solid employment report for May, with 390,000 job gains, was not enough to push stocks higher, and an interview of Cleveland Fed President Mester, where she mentioned a pause in rate hikes in fall is likely not necessary, kept stocks anchored in the red for the day. The S&P 500 fell 1.63% while the NASDAQ fell 2.47% as small caps held up better with the Russell 2000 down just 0.77%.
For the week, the yield curve steepened slightly as the 10-year Treasury yield rose from 2.74% to 2.96%. Oil ended up being a big headline through the week and despite an OPEC agreement to raise production, crude oil still rose 4.5% as the major manufacturing area of Shanghai reopened. The major US indices all finished in the red for the week with the S&P 500 seeing its eighth weekly decline out of the past nine. The indices finished the week as follows: Russell 2000 -0.26%, Dow -0.94%, NASDAQ -0.98%, S&P 500 -1.20%.
Recent Economic Data
- The S&P Case Shiller Home Price Index, where data lags by two months, shows home prices rose another 2.6% in March, well above estimates. Compared to March 2021, the index is up 20.6%, accelerating again from a 20.0% increase in the previous month. Home prices were expected to have started decelerating, but data from the last three months shows that is not the case, in fact, it is the opposite as home prices continue to climb at a faster rate. Tampa (now the fastest pace over Phoenix), Phoenix, and Miami continue to lead the way with increases all over 30% y/y, while Minneapolis, Chicago, and Washington are seeing the lowest growth (all between 12%-13% y/y rates). There is still the expectation that, due to higher interest rates, affordability, and base effects, home prices will start to decelerate.
- The Conference Board’s index on consumer confidence did not fall as much as feared for May, with an index at 106.4, however still down from 108.6 for April. The present situations index fell to 149.6 from 152.9 while the expectations index fell to 77.5 from 79.0.
- Purchasing Manager’s Index – an index on manufacturing conditions. An index level above 50 indicates expanding activity while under 50 indicates contracting conditions:
- U.S. PMI at 57.0 for the May survey, down from 59.2 in April, suggesting manufacturing activity is still growing but at a slower pace than in previous months. New orders slowed from 55.5 to 55.1 while cost inflation accelerated to the fastest since November’s record pace. Also something to take note of, the index for employment fell to 49.6 (contraction territory) from 52.0 the prior month. The report noted the slowing new order growth was in part due to customers pushing back against higher prices, in addition to shortages and growing concerns about the outlook.
- Eurozone PMI at 54.6 for May from 55.5 in April, a new 18-month low. New orders fell for the first time since mid-2020. There were concerns about slower growth and waning business confidence.
- China PMI at 48.1, rising from a 2-year low of 46.0 in April. Firms noted smaller declines in new orders and production but said supply chain problems remain an issue and optimism on the outlook continues to fall.
- Japan PMI at 53.3, down from 53.5 in April. Firms noted supply chain issues are weakening demand with delivery delays and materials shortages continuing to drive prices higher.
- The U.S. ISM manufacturing index was 56.1, much stronger than the 54.5 expected. The ISM survey had more upbeat comments than the PMI report. Prices eased for the second straight month (falling to the upper 80s down from the high water mark of 92), employment improved across all tiers of the supply chain, and sentiment around demand remained strong with five positive comments for every cautious comment.
- Spending on construction rose 0.2% in April, about half the expected growth. Spending was driven by residential construction in April, with the category up 0.9% while nonresidential spending fell 0.4%. Compared to a year earlier, spending is up 12.3% with an 18.2% increase in residential spending and a 6.6% increase in nonresidential spending.
- Job openings dropped to 11.4 million on the last day in April, down from 11.9 million which was a new record high in March. The number of quits was little changed at 4.4 million and remained at record high levels, indicating people are comfortable and confident that they will be able to switch to a better, higher-paying job. Layoffs and discharges moved to a record low of 1.2 million, indicating employers need the employees and underscoring how tight the labor market is.
- There were 200,000 initial jobless claims for the week ended May 28, down 11k from the prior week. The four-week average was 206,500. Continuing claims were 1.309 million, a decline of 39k for a new 53-year low, with the four-week average down to 1.327 million also a new five-decade low.
- The Beige Book, a report on business/economic conditions from each Federal Reserve district, said four districts reported growth was slowing with some softening in consumer spending due to higher prices. Customers are pushing back when it comes to higher prices. Weakness seen in residential real estate. Growth expectations declined in 8 districts. Signs labor market tightness was easing with some hiring freezes, but worker shortages continue.
- Improvement in the labor market continued with payroll growth of 390,000 in May, about 70k more than expected, in what some economists are calling a “goldilocks” report – it was not too many job gains to where the Fed needs to tighten more aggressively but was not low where it would increase concern that the economy is slowing more than expected. Either way, the report remains on trend where the labor market has steadily improved, although there remain more open jobs than people willing to work.
- The details: Job gains were widespread across all industries except retail which lost 60k jobs. The number of those employed is now just 333k below pre-pandemic levels. The participation rate improved to 62.3% from 62.2% as 330k entered the labor force. The labor force is now just 170k people smaller than pre-pandemic. More importantly, the prime-age employment-to-population ratio increased 0.1% to 80.1%, as a new post-pandemic high and moved back to the pre-pandemic levels of 80.5%. The unemployment rate remained at 3.6% with the U-6 at 7.0%, up from 6.7% two months ago. The percentage of those remote working continued its downtrend at 7.4% in May. The average wage increased 0.3%, lower than the 0.4% expected, while wages compared to a year ago were up 5.2%, also lower than expectations of 5.3% and decelerating from April’s rate of 5.5%.
- Facebook parent Meta Platform will change its ticker from FB to META prior to the market open on June 9. Separately, COO Sheryl Sandberg said in a post she will be stepping down as COO after 14 years with the company. Sandberg will remain on the Board for now.
- Amazon shares will begin trading split adjusted on Monday. Shares underwent a 20-for-1 stock split. Recall the market capitalization of the company is unchanged.
- Delta Airlines provided another financial update, saying it now expects total revenue to be “fully restored to 2019 levels” in the current quarter, while capacity will remain 84% of 2019 levels (the last “peak” in air travel), reflecting a 7-8% increase in revenue and 2% decrease in capacity. The increase in revenue is due to higher airfares. Delta also said its cost per available seat mile is 22% higher than 2019 levels, up from the previous forecast of 17% higher, due to higher fuel costs.
- Microsoft issued an update to its guidance, cutting its Q4 revenue and earnings expectations for the quarter citing foreign exchange headwinds. It sees a $460 million impact from forex with EPS down to $2.27 at the midpoint, down from $2.31, and revenue $52.3 billion at the midpoint, down from $52.8 billion.
- Tesla CEO Elon Musk said in an email with “pausing all hiring worldwide” in the subject line to Tesla executives that he had a “super bad feeling” about the economy and said Tesla would look at cutting about 10% of its workforce.
- Bristol Myers Squibb announced it will acquire the clinical-stage oncology biotech company Turning Point Therapeutics for $76/share in cash for a total consideration of $4.1 billion. Turning Point’s lead asset aims to treat non-small cell lung cancer.
- Home furnishing retailer RH gave a warning on softening demand trends, saying the trend of weaker demand began around the time Russia invaded Ukraine, and demand has slowed further during the market disruption over the past several months. It updated its guidance, now expecting slower growth in sales and a lower margin versus its previous guidance issued at the end of March.
- The European Union agreed on imposing its toughest sanctions to date on Russia following its invasion of Ukraine. The group of nations will ban all imports of Russian oil and block insurers from covering Russian shipments of oil, no matter the destination. The move was being discussed for weeks and ended up being tougher than expected. It will not be a complete blockage of Russian oil, as the EU will still allow oil imported from pipelines, an exemption needed to get Hungary to agree (however expected to be phased out as well). The ban includes all imports via ships, which account for two-thirds of Europe’s imports. The ban will be phased in over several months but raises additional inflation fears for the region that just saw its highest inflation reading on record.
- OPEC held its monthly meeting, agreeing to increase the size of its production by 648,000 barrels per day for the next two months, an increase of 216,000 bbl/day from its previous quotas. The deal keeps Russia in the cartel but also follows through after pressure from its largest customers, particularly the US, who have pressured the group to increase production. The new production quotas are nearly 50% higher than its previous quotas. At the same time, reports are saying Saudi Arabia is indicating it is prepared to boost production to offset reduced Russian output from the European Union import ban.
- The narrative around the Federal Reserve’s path of policy eased somewhat the beginning of the week but after hearing from several more Fed officials over the week, a more hawkish tone was felt by investors again. The possibility of the Fed pausing after several 50 basis point rate increases over the summer months rose after Atlanta Fed President Bostic said it was his “baseline view” it would make sense to do so to reassess conditions at that time (its September meeting). That rhetoric was short lived after several other Fed officials downplayed the idea of pausing saying it is hard to make the cause for a pause while reiterating their stance on pushing the policy interest rate above neutral by years end.
- The latest report from the Social Security and Medicare trustees says the Social Security trust funds will not be able to support 100% of payments by 2034. This is one year later than last year’s projections due to the stronger economy, employment, and earnings. In 2034 the fund’s reserves will be depleted and payroll taxes will only cover 77% of the benefits owed. In 2021, about 56 million Americans were receiving benefits. The cost of the benefit is scheduled to grow faster than the US economy mostly due to the aging US population. Congress has three options – reduce benefits, increase the age requirement, or increase taxes.
Did You Know…?
Where Are the IPOs?:
The initial public offering (IPO) market has seen a drastic decline in activity so far in 2022 as companies are pulling offerings due to the decline in the stock market and volatility. In May there were just seven IPOs. Year-to-date there has been just $1.1 billion in capital raised from IPOs, the slowest in five years. Capital raised this year compares with $490 billion raised in 2021, $203 billion in 2020, $109 billion in 2019, and $160 billion in 2018.
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The Week Ahead
The calendar will be quieter this week. On the economic calendar, we will see international trade data on Tuesday, where data is expected to show that US net exports remain near record-high levels, in addition to jobless claims on Thursday. Then the main event for the week will be Friday with the consumer price index. Consensus expectations are for a reacceleration in inflation in May with a 0.7% monthly increase. Earnings season is essentially over with all but several S&P 500 companies already reporting. However, there will still be several releases this week including JM Smucker on Tuesday, Five Below and Campbell Soup on Wednesday, and DocuSign, Nio, Signet Jewelers, and Vail Resorts on Thursday. The busy part of the calendar is the number of investor meetings and industry conferences taking place. Apple hosts its developer conference Monday, AMD, Target, Sherwin Williams, Caterpillar, Salesforce.com, and others will hold analyst meetings, and there will be a number of conferences from different industries.