Markets Cringe at Strong Employment Report
Today’s employment report was shockingly good. Employers added more than 500,000 employees to the payrolls last month alone. Unemployment sank to a new low. Nothing about this seems like the economy is anything less than full strength. That should be good news for investors, right?
Well, except the stock market and bond markets are both down on the news. Investors would have rather heard that employment, and the economy in general, is slowing.
Every once in a while, this happens. Usually when the market is deeply worried about interest rates. Right now, we are in a weird spot where the government (at least the Federal Reserve) is trying to slow the economy so that inflation doesn’t get out of control. They have one powerful tool in their toolbox and it is interest rates. When there is too much money chasing too few goods the Fed raises interest rates and reduces the supply of money in circulation. When it costs more to borrow money, people and businesses spend less – that’s the hope anyway. When there is less money in the economy, ultimately demand will have to come down, and inflation should ease.
Fighting inflation in this way however has always been a bit like trying to steer an ocean liner between 2 icebergs using a remote control with a 15 minute delay. Steer a little too far in one direction or the other, and you crash. By the time you realize you overdid it (raising rates too far, or not quickly enough) you have already either let inflation get out of control, or have tipped the economy into a recession. Add to that the idea that you aren’t the only one with a controller for this economic ship. Congress and the President can come in and start playing with their own remote through spending and tax policies which are often at odds with (better reasoned) Fed policy. For the blather mouths on the opinion news who are always second guessing the Federal Reserve I would say – you try it!
Markets for the past several months have been optimistic that the Fed has oversteered toward slowing the economy. If correct, that would imply that the economy will soon start to slow markedly, inflation will come down, and the Fed will soon change course and start cutting interest rates. Many economists were starting to think we might avoid a recession altogether. If we did have a recession, a quick reduction in inflation and interest rates would imply a recession would likely be mild. This consensus view is why markets have been recovering so well the last few months – January in particular.
Today’s employment report threw a whole lot of cold water on this Goldilocks hypothesis. At least as far as employment goes, the economy is still roaring ahead – Damn the Torpedoes and interest rates! While growth is generally good for stocks, too much growth implies that inflation is not going to come down so easily, the Fed will have to tighten the screws by raising rates more than they thought, and it may take a deeper recession to cure the economy of its inflationary virus. For now, it seems, we are in a weird world where stock and bond markets both would be happier to hear news that the economy is stalling, unemployment is rising, and consumers have stopped spending.
I can’t predict what happens next with the economy or the markets. The best minds in economics have a pretty poor track record in forecasting this stuff, what chance do I have? I have long believed, however, that the fight against inflation will be more difficult than many believe. I suspect that the market has been overly optimistic, and we are probably going to have to give back some of the recent gains that have reflated portfolios since September of last year. Still, the situation is less precarious than it seemed at this time last year. I don’t think another 2022 is in the cards. Bonds in particular seem to be a much safer investment now, paying strong dividends and set to rally if the economy falls into recession. Traditional diversification strategies, target date funds and the like will probably avoid a repeat of the disaster that was 2022, even if stocks suffer another setback.
Our portfolio positioning today is largely the same as it was early last year, perhaps even more defensive as we’ve built up cash positions with 1-2 year CDs and government bonds. (the rates were too good to resist) Our carefully diversified strategies and emphasis on lower priced value stocks and bond alternatives effectively shielded clients from the worst of what 2022 dished out to most investors. At the same time, by maintaining constructive exposure to stock and bond markets, we were able to benefit handsomely from the recent recovery (which virtually no one really expected!).
If you are steering an ocean liner between icebergs with a remote control, “steady as she goes” is probably really good advice.