Investors Increasingly Looking for a Goldilocks Scenario
Nine of eleven S&P 500 sectors finished the week lower, with Healthcare (down 3.1%), REITs (lower by 2.2%), and Financials (off 2.1%) all underperforming the broader averages. Energy (+1.2%) continued to buck the overall downward trend in the market last week. Energy is up roughly +60.0% year-to-date, trouncing the nearly 14.0% loss this year in the S&P 500. West Texas Intermediate (WTI) crude rose +3.3% on the week finishing at over $120 per barrel — its highest level since March 8. Announcements noting the European Union is readying a strategy to partially ban Russian oil, as well as an OPEC+ agreement that falls short of replacing all the barrels of crude lost to the world from Russian sanctions, placed a stronger bid under crude last week. Hence, Energy stocks continue to move higher in an otherwise down-trending market.
Gold ended last week essentially flat at $1,853 per ounce, and the U.S. dollar was stronger, fueled by a +3.0% gain versus the Japanese yen. The 10-year yield settled the week at 2.94%.
Investors See Good News as Bad News
In our view, we are entering a “good news is bad news” type of market environment. Investor anxiety is high. Inflation is at near-record levels. And fears the Federal Reserve is on a collision course to raise interest rates into restrictive territory underpin the challenges stocks face in building sustained momentum to the upside. As such, incoming economic releases that come in stronger than expected, particularly on items of employment and inflation, are likely to be greeted with an adverse investor reaction, as it signals the Fed may need to keep pushing interest rates higher.
Consequently, we believe investors are increasingly looking for a Goldilocks scenario across incoming data points. Notably, the market wants to see trends that show a consistent level of moderation in the pace of growth, inflation, employment, activity, spending, etc., but not enough of a slowdown where it stokes recession fears.
Bottom line: This is a tall order to fulfill and, in some respects, is an unreasonable ask from market participants. While growth momentum and inflation pressures are likely to ease in the coming months (helping reduce the risk that the Federal Reserve overtightens monetary policy), the month-over-month changes in incoming data are unlikely to follow a Goldilocks scenario. Instead, trends could look disjointed over the intermediate-term, which is likely to keep stock volatility elevated and uncertainty high.
The May jobs report is a perfect example of the good news is bad news dynamic. May jobs rose +390,000, while the unemployment rate held steady at 3.6% for the third consecutive month. However, job growth last month was more robust than the +323,000 expected. Although job growth moderated from April’s +436,000 pace (including downward revisions), the moderation was not as much as economists expected. Hence, investors viewed the report as confirmation the Fed could be undeterred in its efforts to raise interest rates to stamp out inflation. As a result, stocks fell on Friday, dashing the possibility of a second consecutive week of stock gains. Instead, the S&P 500 and NASDAQ have closed lower in eight of the last nine weeks.
A Slowdown in Rate Increases Seems Less Likely; The Fed’s Recent Tone is Leading Some Companies to Re-assess Labor Needs
Following Friday’s employment report, Fed fund futures now see the Fed raising rates by 50 basis points at the following three FOMC meetings (June, July and September). Hopes for a pause/slowdown in rate hikes at the September meeting, which had gained some steam recently, were dented in a speech by Fed Vice Chair Lael Brainard on Thursday. Then further damaged by Friday’s employment report. Yet, average hourly earnings rose by +0.3% month-over-month in May, matching April’s levels and coming in lighter than the +0.4% expected. As a result, on a year-over-year basis, average hourly earnings rose +5.2% in May, down from the +5.5% pace in April. And while wages are running hotter for the rank and file workers, white-collar workers are beginning to see pay gains slow more notably.
Over the weekend, Barron’s noted that 66 technology companies handed out nearly 17,000 pink slips in May, the most in two years. In addition, the May ADP report (which tracks private employment) showed private payrolls grew by just +128,000 or the slowest pace since the start of the pandemic. Combined with downward ADP revisions for March and April, and more tempered private hiring across all industries, one can conclude higher wages are starting to take a bite out of the hiring frenzy, despite a tight labor market.
We believe the Federal Reserve is finally beginning to change the narrative around hiring through its commentary and actions, causing industries large and small to critically assess labor needs. Over time, this could temper employee expectations around pay and slow wage inflation. Bottom line: This dynamic is constructive for stocks, the economy, and the labor market as a whole as long as employers don’t aggressively retrench hiring plans. We believe more tempered hiring, easing wage inflation pressures over time, and a more significant number of workers willing to return to pandemic affected industries could create a healthy job market for the longer term.
This Week’s Economic Data Should Provide More Clarity on the Strength of the Consumer
Entering the week, stocks remain oversold. Bullish sentiment climbed higher last week across key reports due to the previous week’s stock gains, but optimism sits well below historical averages. Also, stock allocations among professional money managers sit at their lowest levels in two years, per Bank of America’s Sell Side Indicator. Notably, the number of S&P 500 stocks trading above their 50-day and 200-day moving averages remains well below their five-year averages. In our view, there is additional room for stocks to bounce higher “if” inflation continues to moderate lower, and the market believes the Fed may signal at some point it could slow its rate hiking cycle later this year. Admittedly, those are big unanswered questions at the moment and one reason stocks have had such a difficult time stringing together a more consistent winning streak.
But economic data this week should provide further clarity on consumer trends and inflation dynamics. On Tuesday, the Federal Reserve will provide consumer credit data for April. In the first quarter, revolving credit (mainly credit card debt) surged +21.4% year-over-year, as consumers continued to spend in the face of inflation by borrowing more.
On Friday, the headline May Consumer Price Index (CPI) is expected to increase by +8.2% y/y, slower than the +8.3% pace in April. Core CPI (which excludes food and energy) is expected to rise +5.9% y/y in May, down from +6.2% in the previous month. Investors increasingly view the +8.5% headline CPI print in March as the peak in inflation. However, the rate of change lower from here could hold more sway on stock prices and sentiment. Inflation levels that linger closer to the peak or fall more gradually over the coming months could be greeted negatively by investors, particularly if it implies more aggressive rate hikes later this year. Lingering inflation also wears on consumer attitudes in all wage spectrums over time. The longer inflation sits at or near extreme levels, the greater the risk of eroding consumer spending behaviors. Lastly, the first look at June University of Michigan sentiment on Friday is expected to show a slight uptick from May levels. In May, sentiment sat at its weakest levels since August 2011, amid near-record high inflation and eroding home affordability.
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