More folks on the job means higher yields sooner

Stocks ended last week on a bumpy ride as stocks fell in response to Friday’s employment numbers.  Though the headline number looked weak, traders think that Fed hawks will be undaunted and raise rates with zeal.

N O T E W O R T H Y

Delivery of labor.  Friday was, indeed, a big day for Fed watchers, and these days, everyone is a Fed watcher. Find me someone, anyone who does not know that the Fed is going to raise key lending rates this year. Do you own growth stocks? Of course, you do, and they have been under extreme pressure since late November as the Fed embarked on its asset purchase wind down. In December… one month later, the Fed decided to speed up that taper. Why? So it can clear the table for rate hikes earlier AND, as we learned from the meeting minutes, possibly even start shrinking its balance sheet. These are the Fed’s first line defenses against inflation which continues to instill fear in the hearts of consumers and pain in the wallets of consumers. Instead of the markets applauding such an on-top-of-things Fed, the markets have responded with confusion and discontent. Traders are taking their ire out on the riskiest assets: growthy, growth stocks and lofty cryptocurrencies. The former loses theoretical share value when rates go up and the latter… well, just because. More on those in just a minute.  Let’s look at Friday’s numbers to see why the asset classes closed in the red.

The monthly labor situation has two headline numbers. The first, New Nonfarm Payrolls, came in quite a bit below economists’ +400k predictions at just +199k. That can be safely classified as a miss. The second headline number is the Rate of Unemployment which beat economists’ predictions of 4.1% and printed 3.9%. While the second number can change for lots of reasons, making it somewhat subject to unexpected moves, the first one is straightforward, which is why it is typically the market mover. So, if Friday was just any ordinary Friday, one would expect such a miss in the Nonfarm number to give traders a sense that maybe the Fed hawks will have second thoughts on their aggressive hiking agenda. I am sure that I don’t have to tell you Friday was clearly not just any ordinary Friday, and because of that, traders went a bit further in their analysis, rightly so.  Despite the jumpy nature of the Unemployment Rate, it is still lower and continuing in a downward trend. Looking below the headline numbers we see that Average Hourly Earnings increased by +0.6%, faster than the expected +0.4%, and greater than the prior month’s upward revised +0.4%. Good news for workers but bad news for inflation as consumers will have more to spend and employers will have to pay more for labor.  Finally, a lesser-known part of the employment release is the Household Survey, which I have covered in my notes previously. The headline numbers come from a survey of employers, while the household survey relies on households themselves, as its name implies. So, if you are working for yourself and making money, the household survey would pick that up, but it would be missed in the headline number. The household numbers reflected that +651 new jobs were created and -483k less folks were unemployed from November through December. Those numbers are clearly positive for the country’s labor force and would be unlikely to escape Fed governors. Those same governors have made it clear that if employment was healthy, they would favor inflation-tamping rate hikes. Enough said?

So back to the markets and, now almost certain, rate hikes. I am sorry to beat a dead horse, but higher rates and yields diminish the theoretical value of a stock because they are used to discount future earnings / cash flows. As growth stocks’ current value is so closely linked to future gains, higher yields should, in theory, make those stocks worth less today. Or maybe, those stocks are on the more expensive side, having had superlative returns over the past 18 months. Perhaps those stocks, the riskier ones are ripe for a consolidation. Well run, carefully researched volatile stocks can accumulate great returns over time… but they rarely do it in a straight line, though it may have felt that way since the lows of March 2020 through the highs of late 2021. That may explain why investors are easily spooked when they hear that the Fed may be raising rates sooner than expected. Bond yields have risen and will likely continue to rise only providing a stark reminder of impending hikes. Higher interest rates certainly have the ability to eat into corporate profits, which is why investors need to watch those profits really carefully in quarters to come.  Continued earnings growth will be the ultimate test of a company’s ability to continue to deliver in all interest rate regimes. Those earnings announcements start to bubble in later this week as Q4 earnings season begins. Pay close attention to those.

THE MARKETS

Stocks traded lower on Friday after strong monthly employment numbers. Growth stocks led the broader markets lower. The S&P500 fell by -0.41%, the Dow Jones Industrial Average slipped by -0.1%, the Nasdaq Composite Index dropped by -0.96%, the Russell 2000 Index fell by -1.20%, and the S&P500 ESG Index lost -0.40%. Bonds fell on Friday and 10-year Treasury yields rose by +4 basis points to 1.76%. Cryptos continued their slide giving up -3.99% and Bitcoin lost -2.87%.

NXT UP

• A surge of numbers will hit the tape starting Wednesday which include CPI, PPI, Retail Sales, Industrial Production, and University of Michigan Sentiment.  Additionally, earnings will begin to trickle in this week with official earnings season beginning on Friday with the big financials. Please refer to attached earnings and economic calendars for details.