Is the strong labor market good or bad for your stocks?

Stocks jumped on Friday after investors were gobsmacked by a blowout employment report. The super-strong labor market is great news for the economy but it’s likely to put the Fed on offense.

Hired! It all started with this chart. Have a quick look at it. Go on.

That (☝), my dear friends, is the Phillips Curve, scratched out by economist William Phillips in the later 1950s based on his study of wages and unemployment in the UK from 1861 through 1913. One of his conclusions was that unemployment and wages were correlated. If unemployment goes up, wage inflation goes down. Later on, more well-known economists Paul Samuelson and Milton Friedman (who is an alumnus of my beloved alma mater Rutgers ) made the more direct connection between unemployment and overall inflation. You see, goes the theory, that when the labor market is strong, workers extract more economic rents. Ok, in English, it means that employers have to pay higher wages when they are competing for workers when unemployment is low, and in response, raise prices on goods and services to maintain margins, thus causing inflation. Got it? The Fed certainly did and likely had this very chart framed and hung inside its hallowed boardroom.

The Fed is uniquely focused on unemployment. It is, after all, ½ of its dual mandate to keep inflation low AND, simultaneously, keep Americans employed. That is the primary job of the Fed, and wouldn’t you know it, both of those mandates appear on this very chart above… and they are inversely related, so when one is doing well, the other is not. At the moment, inflation is not doing well, and employment is doing… um, really well, so the Fed is keen on raising unemployment to bring inflation down. It is doing its level best to raise the unemployment rate by raising, raising, raising interest rates, and talking, talking, talking about raising them even more. This has caused havoc to our investments as a side-effect, which is welcomed by the Fed because wealth destruction also eases inflation. The problem is… it doesn’t seem to be working. Well, at least the unemployment part.

You see, on Friday, we learned that the Unemployment Rate is at 3.8%, which is quite low by historical standard, and certainly lower than Fed predictions. We also learned that +336,000 new hires occurred last month, which shocked economists who were expecting a significantly lower number. Oh, and the Bureau of Labor Statistics revised the prior month’s number upward. Folks, that is a strong labor market, and it can only mean that the Fed will be ever more eager to weaken it. You know what that means? Of course, you do. The best-case scenario means rates will remain at these high levels for longer. The worst-case scenario involves more rate hikes, and a healthy amount of FOMC members are suggesting that they would be in favor of more hikes.

After Friday’s release, the market reacted with a rally. One might have expected stocks to fall in response to a strong number and the increased likelihood of more Fed tightening. Rather, the rally suggests that the market upped its bet on a so-called, soft landing. A soft landing would be a good thing as it would mean that unemployment would remain low, the economy would remain strong, and inflation would continue to decline. In other words, no recession necessary. Rates futures suggest that bond traders too, are expecting the Fed to remain on hold for the remainder of the year with the first meaningful chance of a rate cut in June of next year. The week ahead will feature inflation figures which will be closely watched by traders and the Fed. Additionally, the weekend’s troubling news in the Middle East has impacted the price of crude oil, which is also a driver of… inflation, and is already affecting equity index futures. I had all intensions of sharing another chart that shows the breakdown of last month’s jump in hires, but I decided, instead to post a screenshot of Phillip’s journal article, so you know that I actually reviewed the article… I don’t make this stuff up . I read it, so you don’t have to. Here is the fancy citation: Phillips AW. The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957. Economica (London). 1958;25(100):283-299. doi:10.1111/j.1468-0335.1958.tb00003.x

 WHAT’S GOING ON IN THE PREMARKET

Lockheed Martin, RTX, Hess Corp, Marathon Oil, Northrop Grumman, and Occidental Petroleum top the S&P 500 leaderboard this morning, higher by +4.87%, +4.31%, +3.66%, +3.50%, +3.49%, and +3.31% respectively largely in response to the Israel-Hamas war.

American Airlines (AAL) is lower by -3.21% in the premarket after it announced that it is suspending flights to Israel in response to the developing war. Delta and United Airlines shares are also lower in the premarket. Potential average analyst target upside: +27.4%.

FRIDAY’S MARKETS

NEXT UP

• The bond markets are closed today in observance of Columbus Day / Indigenous Peoples Day.
• Later this week: we will get Producer Price Index / PPI, Consumer Price Index / CPI, FOMC Minutes, and University of Michigan Sentiment. Earnings season officially kicks off Friday with JPMorgan Chase. Download the attached weekly economic and earnings calendars for times, details, and to get a jump on your friends.
• Fed speakers today: Logan, Barr, and Jefferson.