October Jobs Report Looks Mostly Stronger than Expected, Perhaps Signaling Fed Has More Work to Do

(Friday Market Open) Lather. Rinse. Repeat.

Today’s October jobs report brought a sense of déjà vu with its headline growth number of 261,000. Though September’s data got revised upward today, that number initially came in at 263,000, so overall, hiring remains robust. 

However, the market appears to be focused on a slight uptick in the unemployment rate to 3.7% from the previous month’s 3.5%. But if you’re the Federal Reserve trying to slow down the economy, this isn’t the kind of report you wanted to see.

With the revisions to August and September adding a combined 29,000 jobs, followed by October’s new strong number, three-month average jobs growth now stands near 290,000. In the years before the pandemic, that would have been excellent news for an economy that wasn’t growing much. Today, it merely signals that the Fed’s anti-inflation fight hasn’t moved far or fast enough. 

Notably, the labor market participation rate fell slightly—a positive sign that higher rates might be having some effect—but growth in manufacturing jobs suggested otherwise.

The market is in the uncomfortable position of rooting against job and wage growth. But the Fed left the clear impression this week it wouldn’t ease the brakes on rate hikes until the job market softens. No single month’s jobs report is definitive, but the last three months of data combined show a very solid labor market likely at odds with the Fed’s plans.

Delving a bit deeper into October’s report by the numbers:

• Average hourly earnings rose 0.4%. That compared with the Wall Street consensus estimate of 0.3% and arguably signaled that a tight labor market and inflationary pressure continue to force employers to pay higher wages to hire and keep employees. Good news for workers but bad for possible wage-generated inflation.
• Labor force participation was little changed at 62.2%. This is a number that would likely be ticking higher if hiring managers were bringing back more people sidelined during the pandemic. Higher participation could also ease wage pressure.
• October’s unemployment rate rise to 3.7% looked somewhat helpful from the Fed’s perspective—and possibly the market’s—at first glance. This might explain why stock future were ahead just after the release. However this isn’t new territory. The rate has fluctuated between 3.5% and 3.7% since March. More déjà vu here. The Fed has projected that unemployment could rise above 4% next year as interest rate hikes pressure the economy, and so far that isn’t happening. Again, good news for workers, not so much for the Fed or investors.
• The number of discouraged workers, or as the Labor Department describes them, “people marginally attached to the labor force who believe no jobs are available for them,” declined by more than 100,000 in October. This could be a positive sign that at least some of these workers might be getting absorbed into the jobs market, which might be giving the market an early lift. 
• However, manufacturing added a solid 32,000 jobs. This likely wouldn’t be the case if the economy were slowing. It also contradicts some recent data showing manufacturing strength ticking lower. If you’re looking for progress in terms of things slowing down or the Fed’s hikes taking hold, you’d want to see this number drop. 

All in all, this was a pretty good report, and not the kind of “labor market finally slowing” one that the market might welcome. The market probably should have sold off on this news, but it did a lot of that work yesterday.

Potential Market Movers

After a week of critical jobs data and the Fed rate decision behind us, let’s turn our attention back to another newsworthy week for the tech sector.

On Thursday, the market slid after weak projections from Qualcomm QCOM and a disappointing stock performance from Apple AAPL. Over the past week, info tech is the third worst-performing S&P 500® sector, and communication services—which includes companies in the search and social media industry like Alphabet GOOGL and Meta META, sometimes thought of as tech—was the worst. It’s partly a function of weakness in semiconductors, though several large companies in that arena saw a bit of rebound in their shares Thursday. The Philadelphia Semiconductor Index (SOX) fell more than 3% Thursday to its lowest close since October 24.

Looking ahead to next week, the economic and earnings calendars get a bit lighter, though the October Consumer Price Index (CPI) report next Thursday will likely be a major touchpoint.

Before that, however, there’s Tuesday’s midterm election to get through. This isn’t a political column, but there’s no way to ignore the possible impact of the vote for industries and the market as a whole.

Every election, we consider the conventional wisdom about what could happen if either party takes charge.

• Many consider gains by Democrats to be good for such industries as alternative energy or to potentially mean tighter regulation for the financials or health care sectors.  
• Others would assume a Republican victory in both houses of Congress would be a fast lane to less government intervention in the energy and health care sectors or fresh spending for defense.

Today, elections and outcomes have clearly gotten more complicated, which is why a recent JPMorgan Chase & Co. JPM analysis points to legislative gridlock as a possible outcome. The traditional market wisdom is to welcome gridlock because it typically means less uncertainty. If decisive majorities for Republicans emerge after November 8, the chances of success for significant legislation go down considerably, according to JPM, considering the Biden administration still occupies the White House the next two years.

However, post-election certainty in any form generally moves markets upward, at least temporarily, the report added.

Between the Fed and a Hard Place

The Fed finds itself between a proverbial rock and a hard place. Even with this week’s hike, the benchmark rate remains below 5%, a level that was considered quite common a generation or two ago. So far, all the Fed’s rate hikes haven’t done much to dent inflation, and it’s worth noting that the last time inflation got this severe, it didn’t retreat until the central bank raised rates into the double-digits back in the early 1980s. That was a very different time, demographically, however, with the U.S. Baby Boom generation reaching its full working age and driving production growth across the economy.

In 2022, by contrast, the population is aging, productivity growth was slowing even before the pandemic, and successive presidential administrations struggled to get Gross Domestic Product (GDP) growth to top 3%.

Except for the post-pandemic surge caused partly by pent-up demand, there wasn’t any sign of the type of mid-single-digit GDP growth we had in the mid-1980s when annual GDP regularly rose 4% or higher. An economy that strong could conceivably better handle higher interest rates, and indeed, rates were regularly 7% or higher back then, even amid some of the best economic growth and lowest unemployment of the period. By contrast, GDP was negative in the first half of 2022 before rising at an annual rate of 2.6% in Q3.

But with today’s different demographics, there’s a lot of doubt whether the Fed can increase rates much above current levels without causing a recession as bad as the one we had in the early 1980s with double-digit unemployment. The Fed wants to slay inflation, but at the same time, not damage the economy too much. In its last dot-plot of economic projections, the Fed didn’t see unemployment returning to 5% anytime soon from the current levels below 4%. But many analysts have doubts whether the Fed can bring inflation back to its 2% target without causing much more widespread job losses.

The higher rates also hurt overseas economies that buy products from the United States because rising rates tend to bulk up the dollar. The increase in rates also can make it harder for companies and countries to finance debt, bringing worries about how the global financial system might respond if a major bank fails due to default. Rising rates can also hurt the U.S. government’s ability to finance new spending, a situation that can reverberate into the stock market if companies with big government contracts see less demand from Washington.

Raise rates enough, the saying goes, and you might break something.

Reviewing the Market Minutes

The Dow Jones Industrial Average® ($DJI) fell 146 points Thursday to 32,001.25. The Nasdaq® ($COMP) had another bad day, falling 1.73%, the Russell 2000® (RUT) lost 0.53%, and the S&P 500® index (SPX) slipped 39.8 points, or 1.06%, to just below 3720. That was below a technical support level that some analysts thought might hold at 3730. A late rally attempt that briefly put the $DJI into the green failed miserably by the end of the day. Technical support is now seen at 3700 for the SPX and below that near 3666.

In the aftermath of the Fed’s 75-point-rate hike, U.S. Treasury yields catapulted toward recent 14-year highs:

• The 2-year Treasury yield, one of the most sensitive to rate increases, closed yesterday at 4.72%, up a dramatic 17 basis points in just a day.
• Combined with only a seven-point increase to 4.12% for the 10-year Treasury yield (TNX), which rose to 4.16% this morning, the gap between the 2s/10s is now 60 basis points. 
• It was under 40 points late last month, and the more inverted that gap becomes, the more it suggests a weakening U.S. economy.

Three Things to Watch

False Start Flag: In football, a false start means the team’s offense “jumps” before the play begins, drawing a whistle and a penalty. Investors learned Wednesday that false starts can hurt the stock market too, especially when it comes to processing and trading on news from the Fed. If you were watching financial news networks when the Fed decision and statement were posted, doubtless you saw the market jump as analysts reacted positively to what they saw as more dovish language from Fed Chairman Jerome Powell and company.

 

The optimism ultimately came down to a single word in the Fed’s statement: “Cumulative.” In other words, investors and analysts embraced the idea that the Fed might wait to see what the “cumulative” impact of all its rate increases would be on the economy before pressing the brakes too hard. There was hopeful talk on the air about the Fed possibly pausing hikes as soon as early next year or just hiking by 25 basis points instead of 75 in the near future.

As we now know, Powell stepped behind the podium 30 minutes later and punctured the positive sentiment. He sounded resolute and made no promises about a pause or even a slowdown in rate increases. He added that rates might go even higher than the Fed had previously projected. How high? He doesn’t know, but the market made its thoughts known quickly. The more rate-sensitive $COMP fell more than 3% by the end of session, and the 2-year Treasury yield touched a new 15-year high of 4.7% by early Thursday. The playbook here is clear: As a trader, being late and right is better than being early and wrong. There’s no “false start” penalty for those who wait and see how the play develops before diving into the pile.

On the Margins: So far, it’s turned out to be a decent Q3 earnings season now that we’re more than halfway through. But there is growing concern about company profit margins. One glance at S&P 500 earnings results explains why. The latest I/B/E/S scorecard from Refinitiv pegs Q3 blended revenue growth at 10.9%, though that slips to 7.6% excluding the energy sector. Earnings-per-share growth excluding energy, however, is an estimated -3.2%. When revenue grows but profits slip, it implies higher costs are eating into bottom lines. Even a staples company like Kellogg’s (K), which beat analysts’ earnings estimates this week, is feeling the inflation pressure on costs, and absorbing them isn’t so easy.  

Steve Cahillane, its chairman and CEO, told CNBC Thursday morning that the company didn’t see margin expansion last quarter and that it looks at pricing on a daily basis. It hasn’t seen so-called “private label” sales taking a bite of its product share but understands household budgets are under pressure and doesn’t want people unable to afford their favorite breakfast cereal. It’s the kind of thing that can keep a CEO up at night. So far, the earnings pressure has been most acute in sectors like communication services, financials, materials, and utilities, according to Refinitiv. When profits sink, it implies the market’s price-to-earnings (P/E) ratio may be out of line and needs to come down. So, not good news for investors, either.

All Hail King Cash: As institutions worry about recession, there’s growing evidence that they’re keeping most of their cash, well, in cash. Long-term U.S. Treasury bonds and even some emerging market stocks are also seeing an influx of institutional money lately, according to a recent Nasdaq report. Emerging markets have become more attractive for their exposure to commodities (many emerging market economies are commodity-oriented). The institutional money going into cash and emerging markets apparently moved out of corporate and high-yield bonds, according to the Nasdaq report. The current move toward emerging markets is somewhat intriguing, considering the strong U.S. dollar typically hurts emerging markets by making imports and debt financing more expensive for those economies, so that leaves the hopes for continued strength in commodities. Emerging market investors got more hope in that particular category when OPEC issued a report Monday saying it now expects oil demand to increase long term.

Notable Calendar Items

Nov. 7: September Consumer Credit and expected earnings from Palantir (PLTR), Lyft (LYFT), and BioNTech (BNTX)

Nov. 8: Election Day and expected earnings from DuPont (DD), AMC Entertainment (AMC), Occidental (OXY), Walt Disney (DIS), and Wynn Resorts (WYNN)

Nov. 9: September Wholesale Inventories and expected earnings from D.R. Horton (DHI), Wendy’s (WEN), and Rivian (RIVN)

Nov. 10: October Consumer Price Index (CPI) and expected earnings from Ralph Lauren (RL), AstraZeneca (AZN), and Dillard’s (DDS)

Nov. 11: Preliminary November University of Michigan Consumer Sentiment

Nov. 14: Expected earnings from Tyson Foods (TSN)

Nov. 15: October Producer Price Index (PPI), November Empire State Manufacturing, and expected earnings from Home Depot (HD) and Walmart (WMT)

Nov. 16: October Retail Sales and Industrial Production, and expected earnings from Lowe’s (LOW) and Target (TGT)

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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