Surprise in Employment

PaulNolte-2What if the jobs reports were switched? June’s blockbuster report of 270K jobs being created gets switched to May and May’s weak report of barely 11k was released last Friday. Would the Fed have increased interest rates at their June meeting? Would the market still be pushing toward new all-time highs? Curious too was the market reaction to the data.

Not only did stocks do well, but so did gold, bonds, international and even energy recovered from a poor inventory report. Usually a report like Friday’s would have investors selling bonds and maybe gold to buy the most economically sensitive parts of the market. This follows on the heels of the release of the Fed minutes in June, indicating concerns about Brexit and job growth that weighed heavily in their decision to keep rates unchanged. So if June’s report was released in May, the Fed would have most likely increased rates. While the jobs report is but one piece of economic data, it is not THE report that drives economic decisions. Looking at the wide variety of releases over the past few weeks, the US economy continues to plod along at below the normal speed limit. Low rates are likely to be around for much longer than many anticipate.

While the headline jobs report was excellent, the wage portion of the report laid an egg. Wage growth remains stuck around 2.5% annually, well below the “booming” rate growth of 4% of prior expansions and just above the lows of prior recessions. If we assume a big error in May’s report and job growth was around a more “normal” 150k, the average of the past few months would still be well below that of similar periods of the past two years. The overall pace of job growth is slowing. On the other hand we’ve had some good news from the service portion of the economy. Last week’s ISM report indicated continued growth and confirmed better data from manufacturing. We do not expect a recession anytime soon, but that also doesn’t mean fast enough growth to create worries about significantly higher interest rates. To borrow a term from the late 90’s, maybe this is a goldilocks period where growth is not too hot, but not too cold to require any changes from the Fed. The drawback is that today’s environment globally is in a precarious position with deflation in a few countries and bond yields below zero on a significant part of global government debt. These are not anywhere near normal times and we expect the markets to remain very volatile in the months ahead as they react to new “news” or just different than expected.

As noted above, bonds, especially governments, continue to attract a huge amount of buyers. This “flight to safety” follows central bankers promising to “do whatever it takes” to get their economies going and to blunt the effects of Brexit. The bond model continues to point to still lower interest rates. Inflation remains modest. While energy prices have jumped since their February lows, many other commodities remain weak. A blend of commodities is relatively unchanged from a year ago and down just over 2% from early June. Without the wage growth (see above) it is hard for persistent inflation to take hold within the economy, no matter how low interest rates drop. An interesting thought about low rates, it forces investors to save MORE just in order to get the desired income in retirement. We remain in the “lower for longer” camp until the economic and wage data significantly improves from their current modest levels.

With yields on government bonds falling to all-time lows, investors have been scrambling for income. Buying nearly anything that is deemed “safe” and with a yield has pushed utilities and many consumer staple stocks into historically high valuation ranges. So where is an investor to go fishing for income? Interestingly, a few of the weaker sectors have some stocks with good yields. Technology and healthcare are both very diverse sectors, from cyber security and biotech to software and pharma. It is the “old” names that have the look and feel of a consumer staple company without the high valuations. Earnings growth for these companies are still good (maybe not great), they pay a decent dividend, it is well covered by earnings and the dividend gets bumped annually. Both of these sectors have struggled during the market recovery since February and provide decent opportunities for long-term investors. The only part of the market that has current yields still above their historical norms are energy stocks, but they could remain volatile.

Will the markets finally break out (higher!) from their two-year trading range? Based upon Friday’s action, investors are very willing to buy with both hands. Declining interest rates, even in the face of “good” economic data gives us pause that both bond and stock investors cannot be correct at the same time. Hopefully the summer will clarify things a bit well before we hit the political season in the fall.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.