This morning, the Bureau of Labor Statistics (BLS) released “The Employment Situation – March 2024.”
In it, the BLS estimated the U.S. economy created 303K net, new payroll jobs last month. This was higher than analysts had been expecting. What’s more, after months of divergence from the Establishment Data, the Household survey suggested an additional 498K Americans found employment last month.
Make no bones about it. This was a blowout report. Sure, there were some key economic sectors which really didn’t add any jobs last month, notably finance and information.
- But 303K payroll jobs?
- The Unemployment Rate falling to 3.8%.
- Wages up?
- Average weekly hours worked higher?
Brother, this report clicked a lot of boxes for anyone bearish on the U.S. labor markets.
The problem was that it was a little too good. It didn’t gibe with a lot of the other data we have. Yes, the most recent ADP Employment Change reported the economy created 184K jobs last month. However, the NFIB Small Business Hiring Plans has been trending lower since September 2022, and currently stands at its lowest level since the worst of the pandemic in the Spring 0f 2020.
Further, the employment surveys in both of the primary ISM Reports on Business, Manufacturing and Services, are below 50. This is basically the over/under line from whether businesses are adding jobs. An observation over 50 implies companies are hiring. One under 50, you guessed it, suggests they aren’t.
Finally, and this is a little less nerdy and perhaps more anecdotal, the website dailyjobcuts.com now has no shortage of articles. This time last year and in 2022, it was pretty thin.
When you add it all up, the private sector’s employment data is, shall we say, not as exuberant as the government’s. The same could also be said of inflation gauges, which could be a topic for a future Common Cents.
Where the rubber meets the road, there seems to be a lot of conflicting data.
However, my confusion, if that is the right word, over the official employment data isn’t the purpose of this week’s missive. It is that the continued ‘hot’ jobs data will put off or otherwise alter future rate cuts by the Federal Reserve.
Essentially, the longer the economy keeps posting monthly payroll growth of 303K, the longer investors will have to wait for a significantly softer monetary policy.
Put another way, money is going to stay more expensive for longer than anyone would like or would have thought at the beginning of the year.
Unless the economy mysteriously accelerates, this could be a problem for investors. First, a good chunk of the stock markets’ rally since November has been due to what we call “multiple expansion.” This means investors are willing to pay more for each “earning per share” than they had been previously. Ordinarily, this happens when expectations are for faster earnings growth in the future, ordinarily the not-so-distant future.
Intuitively, cheaper money gooses corporate profitability.
Therefore, I could sensibly argue that the recent rise in stock prices has been largely due to the conviction the Federal Reserve will cut the overnight rate. This anticipated move would thereby reduce borrowing and debt services costs, which has historically bolstered corporate profits. Absent cheaper money, the onus will be on corporate America to pull a proverbial rabbit out of a hat to make this happen.
Without help from the Federal Reserve, companies will have to figure out a way to grow revenue, cut expenses or a combination of the two to increase earnings. There aren’t really any other alternatives other than accounting gimmicks, which almost always eventually come out in the wash.
So what is easier? Increasing revenue or cutting expenses? You already know the answer. After all, if companies could control their revenues to ensure financial success, no one would ever go out of business. Obviously, we know that isn’t the case.
As a result, companies will have to focus more intently on cutting costs to justify the recent rally and current market valuations. While anything is possible, as the most recent economic data suggests, it would be a pretty neat trick for the private sector to focus on cost containment and have an acceleration in overall economic activity. What is the old expression? It takes money to make money?
But why am I being so glum? Why can’t I stop looking gift horses in their mouths? Why can’t I quit worrying and learn to love the bomb?
Here is the drill. Currently, the price-to-earnings before extraordinary items (P/E O) is roughly 25.0. Wall Street estimates it will be 22.8x by the end of the year and 20.1 by the end of 2025. As such, one of two things has to happen or, obviously, a combination:
- Corporate profits have to increase somewhat meaningfully
- Or stock prices have to fall to meet these predictions
Unless you want to spend hours trying to outthink yourself, there are no two ways about it.
This takes me back to the Federal Reserve. It has two stated mandates:
- Price stability
- Full employment
You would be hard-pressed to find a Fed President or Governor who acknowledges that corporate profitability plays a meaningful part in the monetary policy decision-making process. As such, stock market valuations aren’t the Fed’s primary, second or even tertiary concern. Frankly, they shouldn’t be either.
However, saying the Fed doesn’t have a huge impact on stock returns would be like saying butter doesn’t add calories to a cake. Of course it does, because it influences the price of money and that impacts, well, just about everything in the economy. The cheaper money is, the more likely companies and consumers will consume it in some form or fashion. Intuitively, that stimulates growth. The inverse is also true.
Ergo, as such, therefore, as a result, without some help from the Fed, meaning rate cuts, corporate America will have a difficult time meeting or exceeding earnings expectations.
That isn’t to say it won’t do so. It simply means several, or more, rate cuts would make it that much easier for companies to boost their profits. Historically, and not surprisingly, that is good for stock prices.
So, as I type here today on April 5, 2024, the labor markets continue to be surprisingly strong, at least the official data. That could be enough to postpone any potential rate cuts until a later date. The longer the postponement, the more difficult it will be for companies to meet analysts’ earnings estimates. If they can’t do that, current market multiples are too high and stock prices should come down.
As I told a client this morning, this doesn’t mean a market meltdown or a stock Armageddon, and it shouldn’t. However, it does mean the more ‘we’ rally from this point, and from these already rich valuations, the more prices will fall if the time comes. Again, if the time comes.
In the end, the longer the BLS reports robust payroll numbers like it did this morning, the longer it puts off cheaper money. The longer that happens, the less likely corporate America will be able to live up to expectations.
So, I suppose the moral of the story is, you have to be careful for what you wish.
Have a great weekend.
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 any 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.