Read Beyond The Headlines | Seeking Alpha

Calculator on newspaper headlines about cost of living and inflation

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My concern last week was that Chairman Powell would tip the scales in favor of the bears again when he spoke on Wednesday at the Brookings Institute, determined to cap the rally in stocks over the past two months that might restoke the wealth effect. While his tone was clearly not dovish, his acknowledgement that a soft landing was still plausible and that the Fed must balance the risks between inflation and recession lifted investor sentiment. In fact, the Dow Jones Industrials closed in the bull market territory and the S&P 500 broke above its long-term 200-day moving average. Even a jobs report that was perceived to be stronger than expected on Friday was not able to undermine last week’s rally in the major market averages.

market averages

Edward Jones

The hawks were quick to assert that Friday’s higher-than-expected jobs number for November is inflationary, and the knee-jerk reaction was to sell stocks. Wages also rose more than expected, resulting in a year-over-year gain of 5.1%, which was an uptick from the 4.9% in October. Bears claim that the labor market is still too tight, which will force the Fed to raise rates higher for longer to tame inflation. Yet, this report was not as strong as the headline number suggests, which I think is the reason the market recovered nearly all of Friday morning’s losses by the end of the day.

jobs data

Bloomberg

The payroll number of 263,000 is clearly in a declining trend, as seen in the chart above, but that number is still viewed as too strong because it is estimated to take only 100,000 new jobs per month to absorb population growth. That is the number Chairman Powell said he would like to see, but this ignores the fact that the Bureau of Labor Statistics conducts two employment surveys each month to determine labor market health.

The payroll survey counts the number of nonfarm jobs created by businesses across the country. It excludes the self-employed, who command a large percentage of the working population, and it also does not discriminate between full- or part-time work. Therefore, one worker who finds a second part-time job at a fast food restaurant counts as much as one full-time professional position. The payroll number is also subject to revisions as large as 100,000 in the two months and year following the initial estimate. More recently, the net revisions have been to the downside, which is a trend that should continue.

The household survey counts the number of employed rather than the number of jobs, and it includes the self-employed, which has historically made it more reliable at turning points in the economy. In other words, it tends to lead the payroll number. The household survey has seen job losses in each of the past two months, which suggests that the labor market is not as strong as perceived and that we should see a sharp deceleration in the payroll data in the months ahead.

employment data

BLS

Chairman Powell is aware of this, and I suspect this is one of the reasons the Fed will reduce the size of its next rate increase to 50 basis points. If the next payroll survey catches up with the household survey, it may be the last rate hike, which is my expectation. As for wages, there is a similar divergence.

The service sector continues to outperform the manufacturing sector, which is in line with trends in consumer spending. It is also why the leisure and hospitality category led in job gains last month with 88,000, but these are not high-paying jobs. Therefore, the wage increases in the service sector do not pack the same inflationary punch as higher-paying goods-producing jobs.

wages

Bloomberg

Additionally, the strongest wage gains are being reaped by the 16-24 year-old demographic, which are clearly the lowest-paid jobs to be had. This is having an outsized impact on overall average hourly wage growth. Still, I don’t see this as inflationary as the headline number suggests.

wage growth

Atlanta Fed

Earlier this year, I asserted that the stock market would bottom coincident with the peak in the rate of inflation. Those two events may not have fallen in the same month, depending on the index, but a year from now they should look closely aligned. In fact, the more domestically-focused Russell 2000 small-cap index did bottom in June, which is when the Consumer Price Index peaked at 9.1%. The rally since October has been based on both an easing of inflationary pressures and a lessening of concern about aggressive Fed policy. I think the next leg up will be fueled by expectations for a lower peak fed funds rate over the next three months, which currently stands at approximately 5%. It will come on the tailcoats of weaker economic data, and a broadening decline in prices for goods and services.

terminal rate

Edward Jones

The new walls of worry we will have to climb is the likelihood of a recession in 2023, and the impact that would have on corporate profits, which the consensus still expects to grow 5% on a year-over-year basis. I still see that as a low probability, but it is contingent on the Fed not overtightening monetary policy in the process.

Economic Data

Thank goodness we are in the black-out period before the next Fed meeting, so no Fed speak this week. I think Tuesday’s ISM Services index will be important given the weakness we have seen in S&P Global’s similar survey. Lastly, the producer price index will be closely watched on Friday.

economic data for week

MarketWatch

Technical Picture

There is a growing complacency in the market that does have me concerned on a short-term basis, as the Volatility Index has fallen below 20. The market has topped at levels below 20 this year, but we did see it fall into the mid-teens this time last year. Still, the RSI index is below 30, which is another flashing yellow light.

VIX

StockCharts

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