Following weaker-than-expected August jobs
data, our CIO and Chief U.S Equity Strategist lays out how
the Federal Reserve can ease concerns about a possible hard
landing.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan
Stanley’s CIO and Chief US Equity Strategist. Along with my
colleagues bringing you a variety of perspectives, today I'll be
talking about the labor market’s impact on
equity markets.
It's Monday, Sept 9th at 11:30am in New York. So let’s get after
it.
Last week, I wrote a detailed note discussing the importance of
the labor data for equity markets. Importantly, I pointed
out that since the materially weaker than expected July labor
report, the S&P 500 has bounced more than other "macro"
markets like rates, currencies and commodities. In the absence of
a reacceleration in the labor data, we concluded the S&P 500
was trading out of sync with the fundamentals.
Over the past week, we received several labor market data points,
which were weaker than expected. First, the Job Openings
data for July was softer than expected coming in at 7.7mm versus
the consensus expectation of 8.1mm. In addition, June's initial
result was revised lower by 274k. This essentially supported the
view that the weak payrolls data in July may, in fact, not be
related to weather or other temporary issues.
Second, the job openings rate fell to 4.6%, which is very close
to the 4.5% level Fed Governor Waller has cited as a threshold
below which the unemployment rate could rise much faster. Third,
the Fed's Beige Book came out last week. It indicated that
activity remains sluggish with 9 of the 12 Federal Reserve
districts reporting flat or declining activity in August, though
commentary on labor markets was more neutral, rather than
negative. These data sync nicely with the Conference Board’s
Employment Trends Index, which I find to be a very objective
aggregate measure of the labor market's direction. This morning,
we received the latest release for August Conference Board
labor market trends and the trend remains down, but
not necessarily recessionary.
Of course, the main event last week was Friday's monthly jobs and
unemployment reports, where the payroll survey number came in
below consensus at 142k. In addition, last month's result was
revised lower from 114k to 89k. Meanwhile, the unemployment rate
fell by only a couple of basis points leaving investors
unconvinced that July’s labor weakness was overstated.
Given much of these labor and other growth data have continued to
skew to the downside, the macro markets (like
rates, currencies, and Commodities) have been trading with
more concern about potential hard landing risks. Perhaps nowhere
is this more obvious than with 2-year US Treasuries. As of
Friday, the spread between the 2-year Treasury yields and the Fed
Funds Rate matched the widest levels in the past 40 years. This
pricing suggests the bond market believes the Fed is behind the
curve from an easing standpoint. On Friday, the equity market
started to get in sync with this view
and questioned whether a 25bp cut in September would be
an adequate policy response to the labor data. In the context of
an equity market that is still quite rich and based on well above
average earnings growth assumptions, the correction on Friday
seems quite appropriate.
In my view, until the bond market starts to believe the Fed is no
longer behind the curve, labor data reverses course and improves
materially or additional policy stimulus is introduced, it will
be difficult for equity markets to trade with a more risk on
tone. This means valuations are likely to remain challenged for
the overall index, while the leadership remains more defensive
and in line with our sector and stock recommendations. We see two
ways in which the Fed can get ahead of the curve—either faster
cutting than expected which is unlikely in the absence of
recessionary data; or the labor data starts to improve in a
convincing manner and 2-year yields rise. Given the Fed is in the
blackout period until next week’s FOMC meeting, and there are not
any major labor data reports due for almost a month, volatility
will likely remain elevated and valuations under pressure
overall. This all brings our previously discussed fair value
range for the S&P 500 of 5000-5400 back into view.
Thanks for listening. If you enjoy the podcast, leave us a review
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