Wentz Weekly Insights
Another Strong Jobs Report to Keep Fed on Path
The path of least resistance for stocks remains to the upside following another busy week of mixed earnings report that have mostly come in slightly better than the low bar that was set just before the quarter started. The S&P 500 was able to move 0.4% higher driven by small companies and growth stocks as the growth and tech heavy NASDAQ and small cap Russell 2000 were up 2.2% and 1.9%, respectively. As Raymond James notes, most of the rally has occurred in the most shorted stocks (shorting a stock is betting the stock will go down in value). Stocks that have at least 30% short interest (30% of its shares outstanding are being shorted) have seen a gain of over 30% quarter-to-date while those that have the lowest short interest (less than 5%) saw an average performance of just +8.5% over the same period. The recent rally has been supported by a drop in bond yields as markets began expecting a “Fed pivot” in early 2023.
This was all despite Fed speak last week that reiterated the Federal Reserve is nowhere near done raising rates, not to expect rate cuts in 2023, and it wanting to get to a restrictive 3.5% to 4.0% range by year end (versus 2.25%-2.50% currently). Treasury yields, which recently fell on hopes of a Fed pivot (the Fed adjusting policy and cutting rates versus its current course of raising rates), reversed course last week and moved higher with the 2-year bond yield and 10-year bond yield seeing a sharper inversion. By the end of the week, the 2-year note was yielding 41 basis points more than the 10-year note’s yield (versus the typical environment where investors would demand more the longer they lent their money). It appears Fed members saw the markets took Powell’s press conference as slightly more dovish, and a reset of market expectations was needed. By the end of the week the market expectation of a rate cut was pushed back to July 2023 from the first half 2023.
But the biggest news headline of the week was the July labor report. The Department of Labor said 528,000 jobs were added in July and not only beat the average economists’ expectations, but was double what the consensus estimate was, in addition to the prior two months of job gains being revised higher. The job gains were widespread with services jobs gaining by the most, but every major sector saw gains. Notably, the labor market partially recovered from the pandemic with the number of Americans unemployed finally falling below pre-Covid levels.
However, there is still work to do on the labor market. There are still over 10 million job openings and the number of people with a job is still 470,000 below pre-Covid levels. The challenge in the current environment has been bringing people back into the labor force. In July, the labor force participation rate was 62.1%, dropping for the second consecutive month and the lowest this year. It is not just retirees driving that number lower, the prime working age (age 25-54) participation rate was 82.4%, still almost one-percent lower than pre-covid levels.
Average hourly earnings accelerated in the month with a 0.5% monthly increase, also double the expectations, and a 5.2% increase from the same period a year earlier. This would be good in normal times, but inflation is running at a rate close to 9% meaning real wage growth is a negative 3.8%.
The jobs report confirms the economy likely did not fall into a recession in the second quarter with the labor market showing no slowdown. With inflation remaining high and the labor market still strong, we expect the Fed to stay on path with its aggressive rate hikes in addition to the balance sheet runoff, which will be accelerating over the next couple months. The next big event will be this week’s inflation readings, most notable the consumer price index Wednesday morning.
Week in Review:
Global markets were off to a positive start to the week but U.S. stocks were mixed Monday after reports Nancy Pelosi would be stopping in Taiwan during her Asia visit, despite warnings from China, and Fed President Kashkari, viewed as one of the more dovish members, saying the markets got ahead of themselves in anticipating a “Fed pivot” (i.e. a change in policy direction by the Federal Reserve). It was another defensive day with stapes and utilities outperforming and cyclicals like energy and materials underperforming with weaker manufacturing data which resulted in a 4.8% drop in crude oil. The broader market declined 0.28%.
Stocks got off to another lower start on Tuesday for the same reasons as Monday with Speaker Pelosi landing in Taiwan in the morning. Around the time of her landing in Taiwan, stocks began to recover but shortly after turned negative again from more Fed speak where the message was inflation will remain high and not come down quickly while saying Fed path of rates could remain aggressive as it has a “long way to go,” despite market’s expectation of a slower rate hike cycle and even a cut in rates in 2023. Treasuries had a wild day, with yields falling before quickly recovering. The 10-year Treasury note fell to 2.51%, and inverted with the 3 month yield, before rising to 2.74% by the end of the day. Decliners led advancers with 53% downside volume as growth outperformed value again with the Dow down 1.23% while the NASDAQ lost just 0.16%.
An easing in worries over China/Taiwan situation from Pelosi’s visit along with solid earnings from growth companies overnight and oil dropping by 4% for its lowest level since February (as OPEC raised production quotas another 100k barrels/day) were positive catalysts for the markets on Wednesday. It was another day that favored growth stocks that have seen the sharpest declines since the beginning of the year with the NASDAQ rising 2.59% while defensive stocks underperformed again with the Dow up just 1.29%.
Another wave of earnings were released heading into Thursday, perhaps the busiest day of the earnings season, but included smaller companies than prior days with results very mixed. More Fed speak downplayed the notion rates will be cut in 2023 amid high inflation despite the market’s expectation they will be cut, and other than that it was a more quiet day with the S&P 500 down slightly by 0.08%.
Friday included the nonfarm payroll report where in July there were 528,000 jobs added, well above expectations, with average wages moving higher. This report should provide additional support for the Fed to maintain its aggressive path of raising interest rates. The yield curve flattened more with the inversion widening while stocks were mixed – the S&P 500 fell -0.16% on Friday while the NASDAQ suffered the most, falling 0.50%.
Bond yields moved lower the first couple days of the week before a sharp move higher the second half of the week with the yield curve flattened more. The yield on the 10-year Treasury note rose to 2.83% while the 2-year rose to 3.24% creating a deeper inversion with a 41 basis point spread while the more economically sensitive 3-month and 10-year yield briefly inverted mid-week. Oil continued its decline, falling 10% over the week, while stocks were mostly positive, driven by smaller cap and growth names with the major indices performing as follows: NASDAQ +2.15%, Russell 2000 +1.94%, S&P 500 +0.36%, and the Dow -0.13%.
Recent Economic Data
- The number of job openings in June fell by a relatively large amount, with 10.7 job openings, down 605k from the prior month with the largest declines in retail trade (-343k) and wholesale trade (-82k). The 10.7 million job openings was a large drop, but is still at historically high levels and at levels that were last seen in September (the all-time high was 11.9 million job openings in March). The number of total separations was little changed at 5.9 million while quits was 4.2 million, also little changed from May, and remains very high indicating workers are still comfortable and confident in switching jobs.
- There were 260,000 new unemployment claims filed the week ended July 30, an increase of 6k from the prior week with the four-week average also moving up 6k to 254,750. Continuing claims were 1.416 million, up 48k from the week prior with the four-week average up 11k to 1.368 million. New claims bottomed in April at a 50-year low of around 170k and has since slowly moved higher.
- The Department of Labor employment report showed payrolls grew by 528,000 in July, well above the 250,000 consensus estimates and even well above the top end of the range of estimates, and will likely give the Fed more ammunition and more of a reason to maintain its aggressive pace of raising rates. Job growth was widespread but the largest job gains were seen in leisure/hospitality (+96k), professional services (+89k), and health care (+70k) with sizeable increases in construction (+32k) and manufacturing (+30k). In fact, job gains were seen in all major sectors. The number of people employed rose and is just 470k below pre-pandemic levels while the number unemployed declined and for the first time fell below pre-pandemic levels. One of the only disappointing items, and biggest questions of the labor market, is more people left the labor force with the participation rate falling to 62.1% from 62.2% and below pre-pandemic levels of 63.4%, which caused the unemployment rate to fall to 3.5% with the underemployment rate (U-6) remaining at 6.7%. Wages picked up, rising 0.5% in the month, above estimates, and are 5.2% higher than a year ago, while 13.1% higher than pre-pandemic levels (also a reason to maintain rate hikes).
- The U.S. PMI manufacturing index (50 is breakeven, below 50 is contracting conditions, above 50 is expanding conditions) showed growth continued to slow in July with an index of 52.2 for July, down from 52.7 in June. Output had its first decline since early 2020 with new orders falling at the fastest pace since the same time. However, backlogs continue to build amid labor and material shortages. A positive was a very large move down in “prices paid” index from 78.5 last month to 60 for the lowest level since August 2020.
- The ISM manufacturing index was 52.8 for July, down from 53.0 in June. The bad – new orders at 48.0 contracted for the second month in a row, production at 53.5 fell 1.4 points, backlogs at 51.3 fell, employment worsened, but prices paid saw a massive improvement to 60, down 18.5 points, but still elevated.
- Spending on construction declined 1.1% in June after rising 23 of the past 25 months. The decline was split between residential and nonresidential with spending on residential projects declining 1.6% while spending on nonresidential was down 0.5%. Compared to a year ago spending is up 8.3% with residential driving most the gains, rising 15.4% with nonresidential spending up 1.2%.
- Boeing received FAA approval over the inspection and modification plan for its 787 Dreamliner. The approval could allow Boeing to resume deliveries for the first time since June 2021 when quality issues were found in the manufacturing.
- Walmart said, just a week after cutting earnings forecast, it will layoff hundreds of corporate employees in its merchandising, global tech, and real estate divisions.
- Amazon said it will acquire the consumer robot company iRobot for $61/share in an all-cash deal valued at $1.7 billion.
- In Warner Bro. Discovery earnings call, it revealed it will create a new combined direct-to-consumer brand to be rolled out next summer and it will work on a free ad-supported TV streaming service (to be called Zaslav). Recall the company recently combined Discovery with Warner Bro. and HBO and the new service will focus on combining the brands.
- Less than a year after the House passed a fiscal package, the Senate was able to gain enough support on passing its own. Due to it passing under reconciliation rules as it relates to the budget, it only needs a simple majority in the divided Senate. The bill was recently renamed as the Inflation Reduction Act and has received much attention due to the lack of impact it will have on bringing inflation down. After receiving approval from then holdout Senator Joe Manchin (D-WV), Democrats were able to bring Senator Sinema (D-AZ) on board with its reconciliation package late last week, clearing the way for the proposal to become law. The bill includes many Medicare and prescription drug initiatives, but to gain support Senators adjusted the minimum corporate tax rate, removed the rule that would close the carried interest loophole, added an excise tax on stock buybacks, and tweaked several parts on funding for climate initiatives. Sinema was originally had concerns with the structure of the 15% minimum corporate tax rate, did not support closing the carried interest loophole, and wanted more spending on climate initiatives. The Senate was able to pass the bill over the weekend with all Republicans voting against. It should move to the House by the end of the week then to the President’s desk to sign into law.
- Following the FOMC meeting several weeks ago, there were several Fed officials that spoke publicly last week that provided more details on the Fed’s projected plans to reset the market’s expectations. Much of the comments matched the notion the Fed is nowhere near done raising interest rates, despite markets starting to recently price in a rate cut as early as the first half of 2023, as inflation remains high and the job market remains strong. Minneapolis Fed President said markets are getting ahead of themselves in expecting a Fed pivot as markets started to price in a higher chance of a rate cut in 2023. San Francisco’s Daly said it was “nowhere near almost done” raising rates, Chicago’s Evans said a third 75 basis point hike in September might be appropriate and said the Fed wants to get policy “restrictive expeditiously,” while Cleveland’s Mester said she needs to see compelling evidence inflation in coming down before shifting policy. St. Louis’ Bullard see rates having to get to 4% by year-end, which would be another 150 basis points of increases from here, and that he still believes the Fed can engineer a “soft landing.” (i.e. keeping the economy out of a recession). By the end of the week the market projections pushed the first rate cut to mid-2023.
- In its monthly meeting, OPEC+ agreed to raise its output target by 100k barrels per day for September, which is less than 0.1% of global demand. The meeting announcement follows speculation the group would raise output by a large amount after President Biden’s visit to the Middle East and the agreement to sell missile defense systems to the Saudis and UAE. The September increase compares to the 600k bpd increase that was agreed on for July and August. The actual increase will likely be smaller than the targeting increase though. The increase was divided proportionally across all members, but it still looks like with Saudi Arabia and UAE the only members able to increase production that OPEC production will remain below its targeted levels.
- The 3-month LIBOR rate, which is tied to many consumer debt like credit cards and personal loans, rose for the seventh consecutive day Friday as markets adjust to the steady rise of rates by the Federal Reserve. Consumer’s borrowing costs are sure to go up with the LIBOR rate rising to 2.83% for the highest level since the Great Financial Crisis in 2008.
- In global central bank news, the Bank of England raised its benchmark rate by 50 basis points to 1.75% and emphasized its goal of getting inflation back down to 2% (it was 9.4% in June), while saying its projections are “exceptionally large.” Separately, an official from the Japanese Ministry of Finance said preparations should be made for a return to normal trading in Japanese bonds. The Bank of Japan has been purchasing government bonds for years now to maintain a 0% yield on its 10-year bond.
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The Week Ahead
Second quarter earnings season continues into this week, but at a slower pace than the prior two weeks with about 5% of S&P 500 companies to release results this week. The notable companies reporting this week include AIG, Palantir, and Tyson Foods on Monday, Coinbase, Wynn, Norwegian Cruise, and Ralph Lauren on Tuesday, Disney and Fox on Wednesday, and Illumina on Thursday. On the economic calendar, all eyes will be on the multiple inflation readings we will see this week. The consumer price index for July comes out Wednesday while the producer price index is released Thursday. Consumer prices are expected to have cooled somewhat in July, thanks to a drop in energy, and expected to rise just 0.2% in the month. Import and export prices come Friday morning followed by the consumer sentiment survey while will include figures on inflation expectations. Other than inflation readings, we will see the quarterly update on productivity and costs on Tuesday and jobless claims released on Thursday. Fed speak looks like it will be light this week with just one Fed official speaking publicly.