by Lance Roberts
My articles My offerMy siteAbout meMy videosMy books
Follow on:TwitterSeeking AlphaFacebookAmazon
The August jobs report highlighted a critical reality: the labor market is cooling off. While the headline figures seemed decent, the underlying data reveals clear warning signs that worker demand is slowing. Investors should pay attention because the link between employment and its impact on the economy and the market is undeniable. While often overlooked, as we will discuss, there is an undeniable link between economic activity and corporate earnings. Employment is the driver of a consumption-based economy. Consumers must produce first before consuming, so employment is critical to corporate earnings and market valuations. We will discuss these in order.
Slowing Labor Market: The First Red Flag
The August jobs report indicated that job creation has slowed dramatically, particularly in crucial manufacturing, retail, and services sectors. For months, we’ve relied on the narrative that a strong labor market could buoy the economy through rough patches. But that narrative quickly falls apart as hiring freezes and job cuts become more common. The data trend is always more critical than the actual employment number. The message is simple: employment is weakening.
However, as discussed in the “Sahm Rule,” full-time employment is a far better measure of the economy than total employment. As noted, the U.S. is a consumption-based economy. Critically, consumers can not consume without producing something first. As such, full-time employment is required for a household to consume at an economically sustainable rate. These jobs provide higher wages, benefits, and health insurance to support a family, whereas part-time jobs do not. It is unsurprising that, historically, when full-time employment declines, a recession typically follows.
If full-time employment drives economic growth, it is logical that more robust trends in full-time employment are required. However, since 2023, the economy lost more than 1 million full-time jobs versus gaining 1.5 million part-time jobs. That does not scream economic strength.
Furthermore, a comparison of full-time employment to the working-age population shows why the U.S. can not sustain annual economic growth rates above 2%.
Since the turn of the century, as the U.S. has increasingly integrated technology and outsourcing to reduce the need for domestic labor, full-time employment has continued to wane. If fewer Americans work full-time, as a percentage of the labor force, the ability to consume at higher rates diminishes as disposable income decreases.
Since corporate earnings depend on economic activity, companies continue to adopt technology and other productivity-enhancing tools to reduce the need for labor. If slower economic demand begins to weigh on corporate profit margins, earnings forecasts will be revised downward in the coming months.
Corporate Earnings Are in Jeopardy
Understanding how a weakening labor market translates into weaker earnings is essential. When companies are uncertain about future demand, they stop hiring and look to cut costs. These cost-cutting measures appear in numerous ways, such as layoffs, automation, outsourcing, or increasing temporary hires. Such measures can buy companies some time but don’t solve declining revenues. When fewer people have jobs or wage growth stalls, consumer spending slows down, and that hits the top line for many companies, particularly in consumer-driven sectors. Unsurprisingly, there is a relatively high correlation between the annual change in GDP and corporate earnings.
As such, given that market participants bid up stock prices in anticipation of higher earnings and vice versa, the correlation between the annual change in earnings and market prices is also high.
In past economic cycles, we’ve seen how quickly earnings can disappoint when the labor market weakens. Analysts have been overly optimistic about earnings growth, and now the reality of slower consumer demand will force them to adjust their projections. As earnings expectations come down, investors will need to rethink current valuations. This is a straightforward equation—lower earnings lead to lower stock prices as markets reprice current valuations.
Investors should prepare for a slowing labor market’s impact on stock prices. The market is a forward-looking mechanism, and it’s already starting to price in the effects of weaker job growth. Sectors most exposed to consumer spending, such as retail and travel, are likely to see the sharpest declines in stock prices as investors adjust to the reality of softer earnings.
Technology companies, which have driven much of the stock market’s performance this year, will also be vulnerable. These companies rely on high growth expectations to justify their lofty valuations. If the labor market weakens, consumer demand for tech products and services will also fall, leading to earnings misses and stock price declines.
Investor Implications
The broader financial markets are potentially at risk of a “bumpier ride” as the effects of the weakening labor market ripple through the economy. As we’ve seen in previous cycles, investors will begin to move away from riskier assets like stocks and into safer investments such as Treasury bonds. Such a shift could exacerbate market volatility if earnings get revised lower to reflect slower economic activity.
There’s also the question of how the Federal Reserve will respond. A slowing labor market often leads to lower inflation, which might allow the Fed to cut interest rates more aggressively and reverse the current reduction in its balance sheet. However, if inflation remains well above the Fed’s 2% target, despite weaker job growth, the Fed could find its hands tied. A potential market risk is when the Fed gets forced to keep rates elevated while the economy slows. Such would prolong the economic downturn and increase stock price pressure.
Recent employment reports show a clear trend: the labor market is losing momentum. That spells trouble for the economy and the stock market. The slowdown in job creation, coupled with weaker corporate earnings, is setting the stage for increased market volatility.
As noted, with markets still near all-time highs, it is an excellent time to reassess portfolio risk exposures. Rebalancing positions in overvalued growth stocks and shifting toward more defensive assets could be prudent. As we have often said, capital preservation should be the priority in times of uncertainty. The labor market indicates that uncertain times are ahead, and investors should prepare accordingly.
The post Labor Market Impact On The Stock Market appeared first on RIA.
Full story here Are you the author?You Might Also Like
Japanese Style Policies And The Future Of America
2024-08-30
In a recent discussion with Adam Taggart via Thoughtful Money, we quickly touched on the similarities between the U.S. and Japanese monetary policies around the 11-minute mark. However, that discussion warrants a deeper dive. As we will review, Japan has much to tell us about the future of the U.S. economically.
Let’s start with the deficit. Much angst exists over the rise in interest rates. The concern is whether the government can continue to fund itself, given the post-pandemic surge in fiscal deficits. From a purely “personal finance” perspective, the concern is valid. “Living well beyond one’s means” has always been a recipe for financial disaster.
Notably, excess spending is not just a function of recent events but has been 45 years in the making. The government started
Yield Curve Shifts Offer Signals For Stockholders
2024-08-28
The level of U.S. Treasury yields and the changing shape of the Treasury yield curve provide investors with critical feedback regarding the market’s expectations for economic growth, inflation, and monetary policy. Short- and long-term yields have recently fallen, with short-term maturities leading the charge. The changes result in what bond traders call a bull steepening yield curve shift. The shift is due to weakening economic conditions, moderating inflation, and the increasing likelihood that the Fed will lower rates.
Yield curves are essential indicators that bond investors closely follow. However, many stock investors do not track yield curves despite the importance of bond yields on stock returns. Therefore, in this two-part series, we start with an introductory discussion of
Overbought Conditions Set Up Short-Term Correction
2024-08-27
As noted in this past weekend’s newsletter, following the “Yen Carry Trade” blowup just three weeks ago, the market has quickly reverted to more extreme short-term overbought conditions.
Note: We wrote this article on Saturday, so all data and analysis is as of Friday’s market close.
For example, three weeks ago, the growth sectors of the market were highly oversold, while the previous lagging defensive sectors were overbought. That was not surprising, as the growth sectors of the market were the most exposed to the “Yen Carry Trade. “
We saw much the same in the Risk Range Analysis (Note: both sets of analysis presented are published weekly in the Bull Bear Report).
As explained in the weekly report:
Two critical points. First, three weeks ago, many sectors and
Red Flags In The Latest Retail Sales Report
2024-08-23
The latest retail sales report seems to have given Wall Street something to cheer about. Headlines touting resilience in consumer spending increased hopes of a “soft landing” boosting the stock market. However, as is often the case, the devil is in the details. We uncover a more troubling picture when we peel back the layers of this seemingly positive data. Seasonal adjustments, downward revisions, and rising delinquency rates on credit cards and auto loans suggest a more cautious view. The consumer—the backbone of the U.S. economy—may be in more trouble than the headline numbers indicate.
The Mirage of Seasonal Adjustments
The July retail sales report showed a sharp increase of 1.0% month-over-month, surpassing expectations. However, while that number supports the idea of a
Fed Funds Futures Offer Bond Market Insights
2024-08-21
Profitable bond trading opportunities arise when your expectations about Fed policy differ from those of the market. Therefore, with the Fed seemingly embarking on a series of interest rate cuts, it behooves us to appreciate how many interest rate cuts the Fed Funds futures market expects and over what period. Equally important, Fed Funds futures help us assess the market’s economic growth and inflation expectations.
Currently, Fed Funds futures imply the Fed will start cutting rates in September and reduce them by 2.25% to 3.09% in early 2026. From that point, the market expects the Fed to slowly increase Fed Funds to 3.50%. The limited rate cuts and relatively high trough in Fed Funds tell us the market is not pricing in a recession but a normalization of GDP with inflation running
Market Decline Over As Investors Buy The Dip
2024-08-20
The market’s 8.5% decline during August sent shockwaves through the media and investors. The drop raised concerns about whether this was the start of a larger correction or a temporary pullback. However, a powerful reversal, driven by investor buying and corporate share repurchases, halted the decline, leading many to wonder if the worst is behind us.
However, the picture becomes more nuanced as we examine the technical levels and broader market conditions. While the recent bounce suggests the market decline may be over, risks remain—particularly with the November election looming. Let’s dive into the details.
The August Decline: What Caused It?
August has historically been volatile for markets; this year was no exception. A combination of factors drove the S&P 500’s 8.5% drop:
Are Mega-Caps About To Make A Mega-Comeback?
2024-08-13
Are the “Mega-Cap” stocks dead? Maybe. But there are four reasons why they could be staged for a comeback. The recent market correction from the July peak certainly got investors’ attention and rattled the more extreme complacency. As we noted previously:
“While there have certainly been more extended periods in the market without a 2% decline, it is essential to remember that low volatility represents a high “complacency” with investors. In other words, the longer the market moves higher without a significant correction, the more confident investors become. They respond by raising their allocations to equities (risk) and reducing their allocations to cash (safety).”
As repeatedly discussed in June and July, a 5-10% correction is normal and occurs almost
Tags: Featured,Investing,newsletter
