Hopes of lower rates sooner shot down by employment figures

Stocks traded lower on Friday after monthly employment numbers stunned on the upside. It was a “good is bad” moment for stock investors who are eagerly awaiting the Fed pivot – they may have to wait a bit longer.

Go on, have your cake… but don’t eat it. Come on folks, what do you want to see happen out of all this? Do you want lower interest rates, or do you want to avoid a recession? I have written about this topic often. It’s all about trade-offs. More often than you would believe, I speak with clients who say something like “my objective is to outperform the market with no risk!” Of course, that’s your objective, but a scenario like that simply does not exist. You have to assume some risk to get some return. Now, you can say, “I simply want to beat the market, regardless of risk.” You may also say “I don’t want to take a lot of risk and I realize that it will cost me in returns.” Both of these are reasonable, though extreme. The correct answer lies somewhere in between those two scenarios, and it differs greatly between one person and the next, and from one situation to another.

It is not just we, as individual investors, that must make a difficult tradeoff decision. The Fed must also make a similarly hard decision. It must decide between inflation and unemployment. High inflation is spurred along by low unemployment. More workers have more money to spend. High unemployment also implies that workers are scarce and that employers must pay higher wages to fill vacancies. The resulting higher costs to produce goods and services forces firms to raise prices. Yeah, yeah, we get all that, the Fed has said as much, MULTIPLE TIMES, over the past year. Now that inflation has eased somewhat, investors are starting to price in a rosier outlook. Does that mean lower rates, lower inflation, and a strong economy? That is one version of the illusive “soft landing.” Can that even exist? The market doesn’t seem to think so, based on Friday’s reaction.

In recent weeks, economic numbers have been pointing to a better inflationary environment. The economy appears to be cooling somewhat. Raw material prices are coming down and supply problems are easing up a bit. To be clear, those problems are not gone completely, just markedly better than in 2021 and 2022. Even last week, the Fed admitted that disinflation has begun. The caveat to that is prices are pulling back in goods prices and not yet in services. Ok, so all we need to do is remain patient and eventually those will come down on their own, right? Well, maybe, but first we would need to see the services labor market ease up slightly. Remember, workers are the prime ingredient in the services sectors, and the cost of those workers greatly impacts the price… similar to the price of peanuts affecting the price of peanut butter. That is precisely why all eyes are on the labor market right now, specifically in the services. That is also precisely why Friday’s better than expected New Nonfarm Payrolls number caused the market to spiral.

If the labor market is strong and tight, how can we have disinflation… and lower interest rates. Tradeoffs, right? But my friends, we CAN have both… just not an extreme. I chose to look at Friday’s number in a different way. You, see, I have been concerned of an imminent recession caused by higher interest rates and significantly reduced demand. Listening to all the earnings reports in the past few weeks, that seems to have been the common theme amongst reporting companies. Sales are slowing as a result of “macro headwinds,” and companies are cutting spending to maintain profitability. From a GDP perspective, companies are telling us that consumption (C) is decreased and as a result, they are lowering investment (I). Those are 2 of the four components of GDP and just happens to make up most of it. I am not the only one who is concerned. More and more economists have been raising their projected probabilities of recession. That it something that we all should be concerned about. It takes the markets a lot of time to recover from recession, especially if the unemployment rate jumps. Let’s just say, avoiding that scenario would be good. So, what Friday’s number told me was that the economy is, indeed healthy, AND that inflation is coming down, slowly but surely. In other words, the probability of a soft landing is increasing. The only potential downside is that the Fed may feel the need to keep rates higher for longer, due to the strong employment figure. Interest rate futures responded by factoring in that scenario, pushing rate cuts out by… a month. That seems like a reasonable tradeoff! Decreased probability of recession while having rates top off +25 basis points higher and having to wait until September for the first rate cut. I will take that, and so should you, my fellow long-term-focused investors.

WHAT’S SHAKIN’

Tyson Foods, Inc (TSN) shares are lower by -6.01% in the premarket after the company announced that it missed EPS and Revenue estimates by -36.28% and -1.94% respectively. The company is working through some operational efficiency issues and claims that employment challenges are easing. Further the company has been challenged by falling chicken and beef prices, which has impacted profitability. Ok, good for us as consumers, but bad for us as TSN shareholders. Tradeoffs. Dividend yield: 2.99%. Potential average analyst target upside: +20.7%.

Catalent Inc (CTLT) shares are higher by +28.64% in the premarket after Danaher (DHR) has expressed interest in acquiring the company at a significant premium. Catalent, a pharma contract manufacturer gained notoriety as an outsourced producer for covid vaccines for all three of the big sellers. Very little details have surfaced regarding the interest or probability of the deal occurring. The company will release its Q4 results tomorrow. Potential average analyst target upside: +23.1%.

FRIDAY’S MARKETS

Stocks fell on Friday after monthly employment figures came in better than expected. The S&P500 fell by -1.04%, the Dow Jones Industrial Average traded lower by -0.38%, the Nasdaq Composite Index dropped by -1.59%, and the Russell 2000 Index declined by -0.78%. Bonds fell and 10-year Treasury note yields jumped by -13 basis points to 3.52%. Cryptos dropped by -1.26% and Bitcoin pulled back by -0.33%.

NEXT UP

• The week ahead: lots of earnings as well as University of Michigan Sentiment and FED SPEAKERS are back, starting with the chairman himself, tomorrow. Check out the attached calendars for times and details.
• After the closing bell earnings: Take-Two Interactive, Simon Property Group, Pinterest, Skyworks Solutions, Activision Blizzard, Spirit Airlines, and ZoomInfo.