Did The Jobs Report Signal a Shift in the Economy? A Historical Look at the Jobs Report and Unemployment Rate. Trading Plan for the Week of March 13 2023

The jobs report was very interesting. I know the media has covered this in detail, but I just wanted to quickly add how I am thinking about what just happened on Friday.

We all know that the headline number was higher than expected. This has been the trend for pretty much the entire last year, headline coming in higher than expectations. A number of Fed officials did say that the current run-rate is just too high for the US economy. I think most officials at the Fed wants to see this number at ideally sub 100k.

I know the economy today is different than a couple of decades ago, but let’s quickly take a look at some history to gain some perspective. Remember the dot.com years? I do, it was a very optimistic period when investors were buying anything that was internet related and firms were hiring like crazy. In April of 2000 was the largest monthly print for jobs data at 416k, by July it dropped to just 11k, then two negative prints at just below -100k of job losses. From October 2000 until March 2001 jobs were positive ranging from 94k-268k, before plunging to losses from April 2001 until the first month of positive job gains in March 2002.

The mid 2000s were also quite strong years of job gains, with the peak monthly number of +337k in November 2004. Prior to the economy really falling off the cliff in 2008, there were two months that were negative during that time period, October 2005 (-35k) and September 2007 (-4k). Otherwise monthly job gains were between 90k-200k, all approximations of course.

Then 2008 happened, with February of that year starting us off at a loss of -17k, building to a peak of job losses in April 2009 of -663k. The first positive month was not until April 2010 at +162k.

Why am I discussing history? To illustrate that it is very difficult to predict what will occur next with respect to jobs. During the 2000 dot.com crash, the economy went from strength to job losses in just a couple of months, while the mid 2000s the economy kept pumping out jobs for quite a while.

What is more likely this time, a proverbial cliff that the US economy will fall off or a gentle slope downward? Very hard to say, but what we do know is that a) housing and manufacturing are relatively weak (actually, manufacturing was one sector that declines in jobs last month) and in terms of the leading indicators as various surveys in this are are indicating lack of optimism, and b) services still remains strong.

Can services just drop off completely? No one really knows with 100% certainty. but we are not talking about a specific sector, such as the dot.com/internet/tech stocks of 2000. To suggest that all services across the US will experience a rapid slowdown in demand overnight does not appear to be a high probability event, but never out of the realm of possibility.

The positives in the report were that a) wage growth was lower than expected and b) participation rate increased. One month does not a trend make. Positive, yes, but there is a lot of noise in these numbers.

Back to the employment report. One thing we do know, if history is any guide, is that if the unemployment rate increases by 0.50% from the lows, approximately, it tends to accelerate higher. That is to say, if we get a data point of unemployment at 3.9%+ given the low at 3.4%, I would expect (again, from a historical perspective) that it most likely will not stop in the low 4s, but rather move towards 5% and exceed that level.

Here is the unemployment rate going back to the 1950s. You don’t have to take my word about a move of 50bps higher from the lows, please feel free to take a look yourself. From the low point I added 1/2 of 1% as the red horizonal line. One can see that in the past the unemployment rate accelerated much higher once it breached this point. That is to say, the economy starts to tilt lower and then really moves fast, as firms get worried about demand dropping off, having too many employees it results in higher layoffs, which creates uncertainty for consumers and so on.

The unemployment rate did edge up to 3.6%. This is not the first time it bumped higher recently, with that occurring in September of last year, before resuming the move down to 3.4% last month. I think the market will need to see a couple of months of steady higher unemployment before it sinks in that this figure could move substantially higher. The good news is that if history is any guide to the future, once we see data confirming +0.5% higher from the bottom in the unemployment rate, there is still time to re-adjust portfolios (although I have been cautious for some time, as readers know).

Here is the S&P 500 and the unemployment rate, monthly chart. I added the vertical line to denote the month that the unemployment rate (black line) moved +0.5% from the low. While equity markets were off their peak, there was still a significant pullback following this point. The real question is the magnitude of both the increase in unemployment rate and the potential drop in equities - I have no idea, but I do know that I would not want to try and catch that falling knife, far too risky (again, in my opinion).

I think given the amount of spending that occurred by corporations and the government, along with historic levels of monetary stimulus, due to the pandemic, this has created large imbalances. We are still seeing those imbalances, although many of the goods/supply constraint issues have been resolved.

However, whenever there are such imbalances, there is a high probability (in my opinion) that reactions by monetary authorities will lead to an abrupt tilt in the other direction. In many occurrences this starts with something “breaking”, leading to dominoes falling throughout the economy.

We also have to remember that the economy has massive levels of debt and changes to interest rates could ultimately create large reverberations throughout the economy. Think of it this way, if you make $100k and have $30k in debt, changes to those payments will impact you far less than if you had $80k in debt - it is magnified by the increase in leverage. Now, if everyone else also has higher debt levels, what happens when everyone starts to react in the same way? Those types of interconnected impulses are extremely hard to forecast or model, but I do worry that the bottom could drop off much quicker than people think. As readers know, I have been reading the data as it comes in, which has been stronger than expected, but I do think there is a very real possibility of a quick shift in economic output.

If you didn’t believe me in terms of debt, this chart is Nonfinancial Corporate Business; Debt Securities and Loans, the total liability level from the St Louis Federal Reserve.

The good news, from the Fed perspective, is that tighter monetary policy is working in as much wages are not showing signs of spiraling higher. Wages last month rose just 0.2% for the average hourly earnings. Interesting, the average workweek edged down 0.1 hour. Manufacturing average workweek was down 0.2 hour, overtime moved down as well by 0.1 hour. When an economy slows, the first thing companies do is reduce hourly workweeks and overtime. This could be the beginning of a trend.

If data for March/April/May show similar increases, that would mean that the Fed would stop increases just as the unemployment rate exceeds 50bps off the low. This could lead to potentially a very difficult second half of 2023 for equities.

Silicon Valley Bank (SVB)

Very quickly on SVB. When I first started drafting this newsletter, I was going to discuss the possibility of contagion throughout the economy from the SVB situation. Many businesses have significant funds tied up with the bank. If they can’t meet payroll or pay suppliers, at least for some period of time, it may reverberate through the economy. If I was an employee and learned that my paycheck may be delayed, perhaps I might hold off on a trip/purchase/experience.

What we now know is that the US Treasury, Fed and Federal Deposit Insurance Corp. issued a joint announcement (here) that all deposits will be available on Monday. Also important is a new program by the Fed called the Bank Term Funding Program (BTFP) (here) offering loans up to one year to financial institutions that require liquidity with assets valued at par.

These actions will no doubt calm markets, and the economic fallout, over the short-term. Will this create unintended consequences over the long term (moral hazard)? That is to be deliberated another day, but in the meantime it will help ensure there is no financial collapse this week.

Fed Chairman & Congress

Fed Chair Powell’s comments in front of Congress were a) not a surprise to me, as readers know I have been of the view that taking the “over” in terms of both terminal rate and duration at peak for Fed funds rate was the strategy I have been using for a number of months, and b) the Fed, along with all major central banks, are very well aware of their actions and statements, they do not make public comments without a reason (unless it’s just a mistake, but certainly not prepared remarks).

“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.” This was also noteworthy, “…nothing about the data suggests to me that we’ve tightened too much.”

This is clearly a sign from the Fed to market participants that they will not tolerate continued strength in the economy, especially in services ex-housing. This is not a new theme, just one that some investors have decided to ignore. There have been other Fed officials making the same point, an elevated pace of tightening may be required. Perhaps it was the fact that those officials were not the Fed Chairman that their comments may have been discounted. I’m not entirely sure why equities have been so resilient in the face of labor (services) strength, but I cannot imagine a Fed Chairman to be any more clear.

I printed the following comments by Minneapolis Fed President Kashkari a few weeks ago (newsletter link here) who was very clear (in my opinion), “There’s not yet much evidence, in my judgment, that the rate hikes that we’ve done so far are having much affect on the labor market. We need to bring the labor market into balance so that tells me we need to do more.”

Now the Fed Chairman is essentially making the same statement, if the data continues to remain strong, more will have to be done. This cannot be positive for equities.

The other interesting consideration is that some analysts are now saying the disinflation of goods may further hurt corporate profits. The idea is that corporations have been able to pass along costs plus added margins to keep earnings and revenue growing. However, as goods pricing stabilizes it may create headwinds for revenue growth. Combined with continued pressure of escalated labor costs (which has just indicated perhaps a break in this regard) and this will put additional pressure on profit margins. Again, is this environment positive for equities? Hard to see how, especially when valuations are not cheap.

JOLTS Data

The Job Openings and Labor Turnover (JOLTS) data for January came in strong yet again, although the number of job openings did decrease slightly from December to 10.82 million from 11.23 million the prior month. However, markets were expecting a drop of even more to 10.58 million. Also note that the December data was revised higher to the aforementioned 11.23 from the 11.01 million originally reported.

While construction jobs had the largest decrease in openings, which was to be expected, interesting to see accommodation and food services was the second largest category.

These numbers are still far too high for the Fed. To put these JOLTS figures into perspective, the pre-covid high was in March 2019 at 7.58 million job openings. What is also going to concern the Fed is that since the fall, when rates have increased substantially, job openings have continued to increased. The low last year was in October at 10.05 million and job openings have been higher since that time period. Yes, monetary policy has a lag, but the Fed is beginning to seriously question how far into restrictive territory conditions really are given the continued strength in the labor market, or at the very least the length of time that Fed funds will have to remain restrictive.

Having said all that I wanted to add that JOLTS data can lag quite a bit. For example, during the 2008/2009 GFC, as I highlighted above, the unemployment rate was already increasing at the end of 2007, yet JOLTS data was still very strong. August 2007 JOLTS data was for 4.31 million, which only decreased to 4.04 million in January of 2008. It was a slow decrease in JOLTS data until September/October 2009 at 2.39 million. This may create an interesting situation, in that the Fed is referring to a data point that lags quite a bit (jobs data is also a lagging indicator), yet setting forward looking policies. As I discussed above, there is the very real possibility of a Fed tightening to such a point that the economic activity could drop substantially over a short period of time - the old Wile E. Coyote running straight off a cliff and not realizing the bottom has dropped off, until it’s too late. Is that what will happen? I have no idea, no one does, but given the imbalances and magnitude of monetary policy adjustment along with debt levels, we could be facing such a possibility. Speaking of Wile E. Coyote, I looked at the Acme mail order catalog for a crystal ball, but it appears they are all sold out. Perhaps Bugs Bunny purchased it and is running a hedge fund.

Corporate Earnings

Estimates for Q1 2023 have dropped significantly since December 31st, with expectations of a decline in earnings of -6.1% vs a drop of -0.4% (y/y) at the end of 2022. 81 S&P 500 companies have issued negative EPS guidance so far, higher than both the 5 year (57) and 10 year (65) averages.

As I have discussed before, while analysts are lowering their estimates for the first half of 2023, they are still quite optimistic for the end of 2023. Current estimates are for earnings to increase 9.6% in Q4 2023. If I think about Q4 of this year, assuming the Fed will remain at terminal throughout this period, I find it hard to believe that earnings will re-accelerate to such a degree.

Given all of this uncertainty, investors are paying 17.2 times forward earnings. That is a difficult risk/reward consideration. If, and this is a big “if”, the economy avoids a recession and inflation subsides, that is another matter. However, as I have outlined above, if the unemployment rate exceeds 4%, avoiding a recession will be extremely difficult and (in my opinion) and low probability outcome.

What to Watch This Week

• CPI, of course. Headline and core m/m expected at +0.4%. Cleveland Fed’s Nowcast is indicating a slightly hotter than expected number. I don’t know as it may be the case that we could see a number that hits consensus or perhaps slightly lower. Some inputs, such as energy, were relatively flat during the month, but there were other inputs continuing to push up prices. I would not be willing to wager anything on the number, but I could see a possible bullish impulse if the number were to come in softer, especially when combined with the lower than expected wage data from the jobs report. Combined with statements that SVB depositors would be made whole and there is the potential for a short-term pop higher in equities. Again, I am not making a prediction, just thinking of various paths that markets may move based on the actual report. CPI may set the tone for the markets for the next little while.

• PPI, will it tell a similar story as CPI, drive that narrative or divergence? Stay tuned.

• Retail sales, expectations are for a decline of 0.3% m/m. This will speak to the strength of the consumer.

• University of Michigan Consumer Sentiment. Consumer sentiment is important and I don’t think much will deviate from expectations of 66.9, but worth watching.

• ECB is expected to increase rates by 50bps on Thursday. Europe is dealing with accelerating inflation and higher wages. The reaction in the markets will be very interesting to observe.

Equities

As readers know, I’ve been short for a couple of weeks. Equities will most likely bounce with the news that depositors will be made in full. That does not change my concerns that equities have significant headwinds. Depending on the move Monday, I may take some profits ahead of CPI, it will really depend on how markets react.

CPI is a difficult call, as I noted above we may see a bullish impulse if it comes in weaker than expected. There is support below at 3800 and then at the 200 week moving average near the approximate 3720 area. The uptrend has also been broken, as indicated by the red line. I think there remains headwinds for equities and I will keep most of the position (I do trade around my positions) unless price action indicate to me that this position is wrong, such as a sustained move back above the 4160-4170 area, or CPI comes in substantially lower than expected.

Fixed Income

As I have been suggesting over the last few weeks, a move of the 10 year to yield over 4% is an attractive risk/reward, and we did see others think along the same lines as buyers emerged. I did continue to add to my position above 4%. I would be looking for yield near 3.60% to start taking some partial profits. Now the Fed is set to continue raising rates, and that differential will be an issue as to how far the 10-2 year yield spread can move, but for longer-term holders I think 10 years at 4%+ may look to be an attractive investment.

Oil & Gold

Still sitting on the sidelines in these markets. Oil continues to remain in the “box” that I discussed a few weeks back, no direction yet. Gold has moved quite a bit lately but I am worried this may have been a quick reactionary move and not a new sustained trend. I will wait and watch both markets carefully.

Thanks for reading!

theglobalmacrotrader@gmail.com

Twitter —> @TheGlobalMacro

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