Hot, Hot, Hot: Monster January Jobs Growth Slows Recession Arguments, But Rekindles Inflation Worries

Shawn Cruz, Head Trading Strategist, TD Ameritrade

(Friday Market Open) January jobs growth blew Wall Street’s estimates completely out of the water as the government reported 517,000 new positions created. That compared with analysts’ consensus for less than 200,000 and suggests the labor market is still nowhere near a slowdown.

Stock index futures, which were already under pressure from Thursday afternoon’s less-than-stellar technology earnings reports, saw more selling in the wake of the sizzling monthly jobs data. The report might reignite fears of a more hawkish Federal Reserve just days after a Fed meeting cooled those concerns.

So where do market participants go from here? Many have welcomed recent economic data that’s diminished recession fears, but some may be torn on how to address this report. While this isn’t a sign that rate hikes may stop soon, it’s likely not indicative of an economy on the brink of cratering.

The U.S. 10-year Treasury yield skyrocketed 10 basis points to nearly 3.5% moments after the report came out, a clear sign that investors believe the data points to a more hawkish Fed. 

Digging deeper:

• The unemployment rate ticked slightly lower to a decades-low 3.4% in January and hourly earnings rose 0.3%, in line with expectations. The earnings number should get a close look, as the Fed remains concerned about a “wage-price spiral” as higher prices lead to employees demanding higher pay.
• Beyond the 0.3% wage growth that many are focused on this morning is a number that jumps out quite a bit more: Aggregate Payrolls. It’s a data point that looks beyond what each worker made and sums up all the money being paid out in wages, and in January, it rose an enormous 1.5% month over month.
• The aggregate pay number suggests a lot more money is being paid out to workers, and that’s not going to help moderate demand as the Fed has been hoping. The concern is that the failure of demand to come down could keep inflation flickering and the Fed’s foot on the brake deeper into the year.
• Jobs in the leisure and hospitality sector led the growth in January, climbing by 128,000. These jobs tend to pay a bit less than many others, which potentially helps keep a lid on the overall wages number.
• But jobs in professional and business services, which pay better, rose a solid 82,000 after averaging 63,000 a month in 2022, the Labor Department said. Government added 74,000 jobs and health care added 58,000. Construction and manufacturing job growth was also evident, with 25,000 new construction jobs comparing with an average of 22,000 a month
• The Labor Department also raised November and December job growth by 34,000 and 37,000, respectively, so we’re still looking at a very robust employment market, more robust than people had thought.
• Many people thought all the recent layoff announcements would begin showing up in this report. That didn’t happen.
• Arguments that the country faces recession are hard to make in the face of data like this. It’s also harder to suggest we’re over the inflation hump. The February 14 Consumer Price Index (CPI) for January now grows in importance.

Moving beyond jobs data, there’s been some progress with China’s reopening. The country announced it will fully reopen its borders with Hong Kong and Macau on February 6. Services data for January in China also moved out of contraction, another positive sign. Crude oil is slightly higher this morning, perhaps due to an expected rise in energy demand tied to China’s recovery. Other commodities might also get a lift if the reopening recharges economic activity in Asia.

Morning rush

After the jobs report:

• The 10-year Treasury yield (TNX) rocketed 10 basis points to 3.49%.
• The U.S. Dollar Index ($DXY) rose sharply to 102.1.
• Cboe Volatility Index® (VIX) futures gained ground from morning lows to 18.5.
• WTI Crude Oil (/CL) inched up to $76.31 per barrel.

From hit to miss

After the tech-driven market rally Thursday, earnings from Amazon (AMZN), Alphabet (GOOGL), and Apple (AAPL) all disappointed. This could send Wall Street the opposite direction today.

By now, you’ve likely seen all the numbers, so there’s no point repeating them here. Second-day takeaways include:

• Revenue wasn’t as much the issue for some of these companies as earnings. There’s a lot of noise related to random charges like getting out of office leases and cutting work force, especially with GOOGL.
• AMZN’s rising costs, including shipping costs, could possibly lead to a rise in the price of its Amazon Prime membership program. Keep an eye out for this possibility.
• AAPL’s iPhone and Mac revenue both missed the street’s expectations, while services slightly exceeded. It’s just one quarter, but if the services component remains robust, it could help AAPL’s future earnings thanks to higher margins in services than other aspects of its business.
• Generally, AAPL’s earnings disappointed across the board. Investors in America’s most valuable company likely hope it resolves its global supply chain problems soon with China’s reopening. 
• GOOGL’s YouTube revenue missed expectations. Although this isn’t a huge part of the business, it’s highly visible and one that depends greatly on ad revenue. The soft internet ad environment apparently remains a challenge.

Investors also weren’t happy with yesterday’s earnings news from Qualcomm (QCOM), Starbucks (SBUX), and Ford (F), which all slid in the premarket.  On the whole, yesterday afternoon’s reports were an epic earnings strikeout.

Thinking cap

There’s a growing debate between economists who think the Federal Reserve just delivered its last rate hike of the cycle and others who believe multiple hikes are still ahead.

The first theory posits the Fed knows rate hikes take time to filter through the economy—so a pause to wait and see may be warranted. At least that’s the thinking from research firm CFRA, which told investors this week that the Fed doesn’t want to risk sending the economy into recession by raising rates too high.

The other point of view is to take the Fed at its word. The Federal Open Market Committee’s (FOMC) December projection was for a terminal, or peak, rate of between 5% and 5.25% this year, up from the current level of between 4.5% and 4.75%. That implies two more 25-basis-point increases lie ahead.

For more specific words, look to Fed Chairman Jerome Powell himself. At Wednesday’s post-meeting press conference, he said, “Given our outlook, I don’t see us cutting rates this year,” adding, “If our outlook turns true ... If we do see inflation coming down more quickly, that will play into our policy-setting course.”

Powell noted that the Fed has tools to rectify the situation if inflation falls more quickly than expected and starts to threaten the economy. Worries about deflation—that’s certainly a change of pace. For now, however, the Fed’s fears continue to be focused on inflation, especially because the services sector and wages continue to show strength.

What does the futures market see? As of Thursday, there’s an 85% probability of an additional 25-basis-point rate hike in March, basically unchanged from before Wednesday’s meeting, according to the CME FedWatch Tool. There’s only an 14% chance of no hike in March.

Market participants still pencil in nearly 60% chances of the Fed reducing rates before the end of the year, FedWatch said. But it’s debatable whether that’s good or bad news. If the Fed cuts rates in 2023, it’ll possibly be in response to a recession, which no one likely wants. Remember Powell’s warning Wednesday, however, that he knows the Fed’s rate policy could cause slower growth.

Reviewing the market minutes

The major indexes might’ve gotten a bit over their skis yesterday, especially the Nasdaq Composite® ($COMP). Optimism ahead of the afternoon earnings reports from AMZN, GOOGL, and AAPL helped launch a 3.25% rally Thursday in $COMP, but none of the three companies impressed with their results after the close, and all came under pressure premarket.

Before the close, things looked rosy right across the board with the exception of weakness in the Dow Jones Industrial Average® ($DJI). That red mark on Wall Street stems from the trend discussed above in which investors have begun moving back into growth stocks from more value-oriented names like the big industrials that make up the $DJI. Softness in AAPL, a $DJI component, could keep the pressure going today for that index.

Here’s how the major indexes performed Thursday:

• The $DJI fell 39 points, or 0.11%, to 34,053.
• The $COMP rose 3.25% to 12,200.
• The Russell 2000®(RUT) jumped 2.06% to 2,001.
• The S&P 500 index (SPX)climbed 1.47% to 4,179.

It appears major indexes got a bit stretched yesterday, and these recent highs may be hard for bulls to defend.

Three Things to Watch

Shades of 2019: The pre-pandemic info tech and communication services rally is enjoying a second act this week as many investors think the Fed and other central banks are approaching the finale of their respective rate-hike cycles. It’s no coincidence seeing stocks like Meta (META), Nvidia (NVDA), Tesla (TSLA), and Alphabet (GOOGL) among the list of market leaders late this week because so much of the growth-stock thesis relies on a lower-rate environment. While the Fed certainly didn’t promise rate cuts (in fact, it forecast additional hikes), the very fact that Powell and company aren’t taking greater aim at looser financial conditions seems encouraging. It isn’t just tech stocks rallying. Other rate-sensitive stocks like homebuilders also got an injection of bullish energy yesterday.

Growth is back, but watch valuations: As growth and rate-sensitive stocks climbed the ladder Thursday, the $DJI sagged following disappointing earnings from traditional-economy stalwarts like Caterpillar (CAT) and Honeywell (HON). The industrials, materials, and energy side of Wall Street’s ledger all stood on the sidelines as investors flocked to “new economy” names. It’s easy to understand this dichotomy if you look at one-year performance, where energy, health care, industrials, and materials stocks top the leader board and info tech, consumer discretionary, and communication services occupy the very bottom of the standings. There could simply be pent-up investor demand for sectors that suffered in 2022. Whether this makes sense from a valuation standpoint is another question. Both info tech and consumer discretionary are among the sectors with the highest forward price-earnings (P/E) ratios on the Street.

Out of whack: A few more things seem counterintuitive here as the weekend approaches. For one thing, fixed income yields are dropping worldwide despite the Fed’s, Bank of England’s (BoE), and European Central Bank’s (ECB) rate hikes. Many might wonder whether rate hikes should cause bond yields to rise, and they’d be right to ask that. Another question is why did the dollar rise yesterday despite many signs of weak U.S. economic growth? Perhaps the stronger greenback benefited from the promise of more Fed rate hikes and buying interest near recent eight-month lows. The recent dollar weakness appears to be helping overseas economies, especially in Asia where some data looked a bit better this week. Another question is this surprising weakness in volatility despite so much news about slowing economic indicators and companies laying off employees. Should investors really be so sanguine, especially with key U.S. inflation data arriving at mid-month?

Notable calendar items

Feb. 6: Expected earnings from Cummins (CMI) and Tyson Foods (TSN)

Feb. 7: December Trade Balance and Consumer Credit and expected earnings from BP (BP), Centene (CNC), and Hertz (HTZ)

Feb. 8: December Wholesale Inventories and expected earnings from Bunge (BG), Uber (UBER), and Yum Brands (YUM)

Feb. 9: Weekly Initial Jobless Claims and expected earnings from AbbVie (ABBV), AstraZeneca (AZN), Baxter (BAX), and PepsiCo (PEP)

Feb. 10: University of Michigan February Consumer Sentiment and expected earnings from Enbridge (ENB) and Honda Motor (HMC)

Feb. 13: No major earnings or data of note

Feb. 14: January Consumer Price Index (CPI) and expected earnings from Coca-Cola (KO) and Marriott (MAR)

Happy trading,                                  

Shawn

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