The November jobs report confounded many analysts as it both missed expectations and showed some odd internal inconsistencies. As always, Peter Boockvar cuts through the numbers to tell us what they mean.
Key Points:
- November payrolls grew just 210,000, far below the 550,000 Wall Street estimate.
- Labor force growth of 594,000 was still enough to push the unemployment rate down to just 4.2%.
- The participation rate ticked up to 61.8%, highest since March 2020 when it was 62.6%.
- Average weekly earnings rose 0.5% from October and are up 4.8% in the last year.
- Leisure/hospitality wages continued rising sharply but service sector jobs growth seems to be slowing.
- Labor supply remains a big challenge.
This report may look disappointing at first but Boockvar still sees enough internal improvement to think the Fed will stay on course and maybe quicken the taper plan.
The Fed
After spending months arguing that the surge in pandemic inflation was largely due to “transitory” forces, Fed Chair Jerome Powell told Congress on Tuesday that it’s “probably a good time to retire that word.” Many have taken issue with the verbiage in recent months, given that Powell has acknowledged that inflation is proving more powerful and persistent than expected. As a result of the price pressures, the Fed is now considering a faster tapering to its asset purchase program, shifting gears to tighter monetary policy.
Can tapering be good for the markets? While stocks sank after the comments – with traders boosting bets on upcoming interest rate hikes – futures are already pointing to renewed gains this morning. Volatility may still be the name of the game, but if history is any guide, the Fed’s “taper tantrum” of 2013 was followed by strong gains for equities, as traders bet the economy was healthy enough to stand on its own. Following Ben Bernanke’s comments in May 2013, stocks fell 5.8% in the next month, but for the rest of that year, the market was up 17.5%.
However, Inflation doesn’t generally help earnings growth.
“The old adage that markets hate uncertainty couldn’t be more true, and it’s going toe-to-toe with another well-known force, investors’ love of dips,” added Craig Erlam, senior market analyst at OANDA.
Powell’s testimony to Congress suggested that the Fed is pivoting from being worried about a faster labor market recovery toward being more concerned about keeping a lid on prices. “The risk of higher inflation has increased,” explained Powell, who was tapped for a second four-year term by President Biden last week.
Inflation
“Inflation” can vary a lot depending how you measure it. The Federal Reserve prefers a Personal Consumption Expenditures price index, which the Commerce Department compiles as part of the GDP database. “Core PCE” excludes food and energy prices. We see in this chart that core PCE annual growth (blue line) stayed between roughly 1% and 2% for the entire decade before this year. Then it quickly shot higher and is now at 4.1% for the 12 months ended October 2021.
Remarkably, even though the Fed’s preferred inflation gauge has been in a clear breakout since April, the Fed is still stimulating more of the same. The “taper” policy is not a “tightening.” It is simply stimulating at a slightly lower pace, and will not reach neutrality until June 2022. Fed policy is only one part of the inflation picture, and not necessarily the most important one. Nonetheless, monetary policymakers don’t seem overly concerned with inflation or they would be moving much faster.
Both inflation and deflation aren’t good for stock investments. The “sweet spot” is generally when inflation is between zero and 3% and valuations are much lower. We are well past the valuation and inflation metrics of the tech bubble.
That suggests one of two things needs to happen: either inflation needs to drop dramatically or the stock market needs to drop significantly, or some combination of the two—at least from a historical perspective. Depending on how you measure standard deviation, we are somewhere between 4–5 standard deviations from the mean. Again, dramatically higher than the Roaring 20s (well more than double) or the tech bubble (more than 50% higher).
Jerome Powell decided to remove the word transitory from Fed-speak and is talking about ending quantitative easing faster so that they can get on to actually raising interest rates and leaning into inflation. If he follows through on this signal, I will applaud him. Notwithstanding the bipolar market movements of the last week, I am not sure that investors will be as pleased. While I think that the market could rise into year-end (the typical Santa Claus rally), I am not as sanguine about the first half of 2022. The potential for a real bear market triggered by earnings compression and Federal Reserve actions is quite real.
The question of the day, and it is truly a question that I don’t have an answer to, is what will Jerome Powell do if the stock market falls 20% and inflation is still at 4%? And they haven’t even begun to raise interest rates? Does he follow the Fed’s mandate and lean into inflation, calling up his inner Volcker, or does he look to his unwritten mandate of giving the stock market what it wants?
Those of us who were in the “business” in the 1970s know they were burning effigies of Paul Volcker for his tight money policies. It was the right thing to do, but it was not popular on Wall Street.
Needless to say, but I’ll still say it: This is not normal. Everything we see about today’s markets screams “overvalued.” Let’s look at some data from Ed Easterling at Crestmont Research who provides the raw numbers from the people at Advisor Perspectives.
First, the Crestmont P/E ratio is at its highest level ever. I really think Ed’s P/E ratio is the best out there in terms of taking into account history and trends. But you can do this with the Shiller ratio or the S&P data. It all shows the same result.
The Crestmont P/E of 43.9 is 198% above its average (arithmetic mean) and at the 100th percentile of this fourteen-plus-decade series. We’ve highlighted a couple more level-driven periods in this chart: the current rally, which started in early 2014, and the two months in 1929 with P/E above the 25 level. Note the current period is within the same neighborhood as both the tech bubble and the 1929 periods, all with P/E above 25 and is certainly in the zone of ‘irrational exuberance.
But that has to be put into context and sadly, the current context is not exactly bullish. Next year is truly unknown territory. The Fed has signaled it will begin to reduce quantitative easing. Even though its balance sheet will be expanding, it is a tightening of monetary conditions. It remains to be seen how fast they will do it. There are other unknowns, too.
US Economy
- US durable goods orders keep climbing. The persistent strength in capital goods orders points to robust business investment.
- US wage growth has decoupled from the rest of the developed world. Is this trend sustainable?
- Remittances hit a record high.
- By the way, sending people to wealthy countries (legally or illegally) is a massive source of capital inflows for many EM economies. There is no incentive for governments to “stem” the flow of migrants.
- The ISM Manufacturing report was in line with expectations.
- Hiring picked up.
- Businesses continue to build inventories.
- There are signs that supply-chain bottlenecks are starting to ease.
- Initial jobless claims hit a multi-year low for this time of the year.
- Continuing claims, which are reported on a one-week lag to initial claims, are nearing 2018/19 levels.
- Announced job cuts are now the lowest in decades
- These rapid improvements in the labor market are allowing the Fed to accelerate QE taper.
- This chart show the components of the PCE inflation index.
- Economists expect inflation to moderate but hold above 2%.
- A large portion of the inflation spike is still driven by COVID-related trends.
- Core goods inflation has risen significantly above pre-pandemic growth trends, which can lead to disinflation next year, according to Barclays.
- Container shipping rates are easing.
- Manufacturers are not concerned about backlogs persisting for too long, according to the Dallas Fed’s regional survey.
Market Data
- The news of a COVID variant called omicron spreading in South Africa and elsewhere spooked investors around the world.
- Reopening stocks tumbled
- Airlines stocks got hit particularly hard
- Bank shares also underperformed as Treasury yields dropped.
- Flows into stock funds have been unprecedented this year.
- Q3 share buyback activity hit a quarterly record.
- The omicron scare sent rate hike probabilities sharply lower. Nonetheless, the odds of three Fed hikes next year are still above 70%.
- Inflation expectations dropped.
- Some analysts have been predicting that value stocks finally bottomed relative to growth. So far, they have been proven wrong.
- Small caps continue to underperform.
- 2021 has not been a good year for bonds.
- The rally in commodities has faded for now.
- S&P 500 breadth has weakened throughout the year, which means fewer stocks have been participating in the broader market uptrend.
- The controversial Hindenburg Omen, which compares new highs versus new lows, just triggered.
- The S&P 500 is below its 50-day moving average
- Major US indices have diverged, with the Dow slumping by over 5% in recent weeks.
- The share of NYSE stocks closing above their 200-day moving average dipped below 50%.
- Momentum stocks continue to underperform.
- Small caps are down sharply, with microcaps now in correction territory.
- Crude oil has dropped 20% from its peak. This is a relatively quick bear market, and ends a long bull run. Those developments had a tendency to lead to poor future returns in oil, Energy stocks,and the Canadian dollar.
Thought of the Week
“Becoming old means:
- Losing interest in life
- Accepting the notion that it is too late to change
- Believing that life doesn’t matter anymore
- Failing to set goals and commitments
- Losing your sense of surprise and giving in to boredom”
Pictures of the Week
All content is the opinion of Brian J. Decker
