Stock market futures are negative this morning, as investors consider unexpectedly strong data on the labor market. Nonfarm payrolls increased by 263,000 in November, versus a revised gain of 284,000 in the prior month. Last month’s unemployment rate held steady at 3.7%, while average hourly earnings advanced a hot 0.6%, compared to 0.4% growth in October, and the labor participation rate slipped 10 basis points, to 62.1%. The domestic labor market appears to be losing a bit of momentum. Still, there are more than 10 million jobs available and only 4 million people actively looking for employment. Most companies continue to be hard pressed to fill job vacancies with qualified individuals. It will take some time for wage inflation to meaningfully subside.
The major market indexes may be hard pressed to post improvement for all of this week. Over the first two and one-half days of trading, share prices generally moved lower. Then, on Wednesday afternoon, Federal Reserve Chairman Jerome Powell indicated that the central bank would probably hike short-term interest rates another 50 basis points, rather than 75 basis points as many on Wall Street had feared, at its upcoming mid-December meeting. On that news, stocks surged higher. We note that the Dow Jones Industrial Average (DJIA) has technically entered bull market territory, that is, an increase of more than 20% from a recent low. Today’s data, however, has put a damper on momentum.
A rate hike of one-half of a percentage point this month would bring the benchmark Federal Funds range to 4.25%-4.50%. In recent days, there has been additional evidence that the Fed’s efforts to bring down inflation are having an impact. Home prices and sales are trending lower, job openings have declined, the rate of workers quitting has eased, the Personal Consumption Expenditures (PCE) Price Index has incrementally moved down, consumer confidence is tepid, construction spending has slackened, and readings point to a moderate contraction of manufacturing activity. Conversely, some data are showing ongoing economic strength. Personal income remains on a positive track; jobless claims growth is limited; spending on the part of consumers is still rising; and real gross domestic product increased a solid 2.9% for the third quarter. On balance, current data suggest that the Federal Reserve will further hike interest rates through early 2023, though likely in modest increments. Ultimately, the Fed Funds range may peak near the 5% interest-rate mark.
Wall Street, not surprisingly, is hoping for a “Santa Claus” rally, which is typical this time of year. Indeed, this could be the case. The blue-chip DJIA might well narrow its calendar 2022 losses to the single digits. That said, it will be difficult for the broader Standard & Poor’s 500 index and the NASDAQ composite to avoid double-digit losses for the year.
Looking to 2023, there is risk to the stock market despite the fact that much froth has been skimmed off valuations. The Fed appears inclined to soon suspend rate hikes to see what its handiwork has done. However, an inverted yield curve, with short-term Treasury rates above those of longer-dated government bonds, indicates that a recession is coming, if not already here. Should the economy slow markedly, corporate earnings would come under stress. That would have the effect of raising stock price-to-earnings “multiples” as the earnings element of the calculation falls, potentially again pushing investors toward the exits. Under such a scenario, the central bank could be prompted to start cutting interest rates as long as inflation continues to abate. In our view, should a recession materialize, it probably will be mild. Share prices ought to hold up reasonably well, but volatility might rise through next year. Investors may want to stay with high-quality equities, such as those in the healthcare and communications services sectors, over the next few quarters.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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