This morning, the Bureau of Labor Statistics (BLS) released “The Employment Situation – December 2024.” If you have been reading this newsletter over the last 12-months, you know I have been a little perplexed by the vibrant “payroll” growth the BLS keeps reporting. What’s more, the BLS’s own data seems to contradict itself.
Then, there all of the revisions, and the revisions of the revisions, which have made me question the data even more. Unfortunately, today’s report offered more of the same. Brand new year, same old stuff. Frankly, keeping up with the vagaries in the report and juxtaposing the data with information from Bloomberg is getting sort of confusing.
Perhaps that is the point.
Regardless, the point of this week’s issue is the markets’ dramatic reaction to the report. It was a blowout, and I mean way better than most thought possible.
- The Household Data suggested the economy added 478K jobs during the month, seasonally adjusted to account for the holidays. As a result, the official unemployment rate fell back down to 4.1%.
- Along the same lines, the Establishment Data reported an additional 256K net, new payroll jobs, again seasonally adjusted. This was 3.5 standard deviations to the right of the median estimate in the Bloomberg survey, 165K.
It seems others are as baffled by the Employment Situation reports as I am.
Despite my misgivings, and the apparent misgivings of others, the official data is what it is. The economy created a lot of jobs last month and the unemployment rate fell. I, you, we can bray at the moon about it. We can wring our hands and gnash our teeth, but it won’t matter.
According to BLS, the labor markets are almost as tight as a drum.
If the bureaucrats are right, this means the Federal Reserve doesn’t need to be in a hurry to cut the overnight rate. After all, the Fed has a dual-mandate of price stability and full employment, and few could argue 4.1% isn’t pretty full employment.
This is where it gets even more weird.
Investors secretly suspect the economy isn’t as red hot as Washington would lead us to believe. There are simply too many anecdotes to the contrary for them to be anecdotal. Further, after two consecutive years of outsized returns in the domestic markets, what can stocks do for an encore this year without a little happy juice from the Fed?
Without it, despite President Trump’s promises and braggadocio, corporate America is going to have a hard time significantly accelerating earnings without even cheaper money.
Leading into today, the investment markets were in between a rock and a hard place.
- IF the data was too strong, the Federal Reserve might hit the brakes, and investors wouldn’t get the rate cuts they crave.
- Conversely, if it was too soft, that would suggest the economy was veering into the ditch. Obviously, that isn’t good either.
As such and if you will, there was little margin for error. In order for investors to shrug off this morning’s report, the payroll number needed to be well within one standard deviation of the median estimate, and the unemployment rate couldn’t budge from 4.2%.
Really, anything over 175K and under 140K net, new payrolls jobs was likely going to cause problems. The more the data deviated from the analysts’ survey, the deeper the red ink was going to be when the markets opened.
Preparing for Volatility
Recognizing this narrow margin for error ahead of time, our Investment Committee sold 50% of the direct small-cap exposure in our “strategy portfolios” this past Monday. With the proceeds, we purchased a short-term U.S. Treasury fund, essentially a cash alternative. The end result was the lowest overall allocation to equities in probably a decade, if not longer, and the highest “cash equivalents” allocation in recent memory.
If you have looked at the markets since this past Monday, you can imagine we are both happy with the trade AND wish we had sold even more. Even so, it was still a pretty decent lick. One which some firms would have been paralyzed from doing.
But where does this leave us now?
The jet fuels for any substantial rally are higher-than-expected earnings and cheap money. We haven’t hit the peak of the 4th quarter earnings season, so it remains to be seen just how well corporate America did to end 2024. The rate cuts the Fed has already done will certainly help. However, with a spread of +1.8% between the target overnight rate and the 12-month CPI, it is hard to say money is cheap.
As a result, while earnings seasons are always important, this upcoming one is even more so. Companies the markets ordinarily overlook will get a lot of attention. The talking heads on the television will drone on about the Big 7 well in advance of their releases. For grins, these are: Apple, Amazon, Microsoft, Nvidia, Alphabet, Meta and Tesla.
You know, those large-cap growth stocks which have put a bottle rocket in the indices over the last umpteen months, if not years. Since these stocks, alone, make up around one-third of the S&P 500, they a need strong year-end performance to make investors happy in the new one. Trust me, any wobble in revenue and/or profitability for these companies could led to an exaggerated negative reaction in the index as a whole.
It all boils down to this.
Thanks to this morning’s curiously strong jobs report, the Federal Reserve is likely on the proverbial sideline through the end of the 1st quarter, maybe even through April or May.
That means, unless something bad happens elsewhere, money won’t get any cheaper in the near-term. As a result, strong corporate earnings have to be the catalyst for a strong stock market rally.
Since the Big 7 are such a disproportionate weight in the U.S. indices, their earnings results will have a disproportionate impact on the overall market. If they are mediocre, you can expect mediocre returns, fingers crossed. If profits grew faster than expected, there might be another leg up on last year’s rally. If they come in less-than-anticipated, well, look out below.
However, as for the Employment Situation report itself, it was a real head scratcher. However, it DID put the Fed on hold for the time being. This means strong 4th quarter 2024 profits and robust “forward guidance” from a select few firms will have to be the fuel for the markets to expand on last year’s rally. Period.
That much is not confusing.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this and every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as well as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.