By Dr. Uric Dufrene, Sanders Chair in Business  Professor of Finance, Indiana University Southeast

As the summer comes to an end, the past two weeks brought us more fun with another ride on the wild roller coaster stock market ride.   The ticket to this ride was made possible by Fed Chairman Jerome Powell, through remarks made at Jackson Hole, WY for the annual Kansas City Federal Reserve annual economic summit.   Uttering the words “keep at it” was enough for a market plunge, shedding more than 1,000 points on the Dow.   About ½ of summer equity rally gains have just about evaporated, with the Dow shaving about 2,000 points in just two weeks.

The Powell talk helped reversed market perceptions that the Fed would be able to pivot away from more aggressive rate increases.    Hence, the reaction was swift and ferocious.   The irony is that the adverse market reaction occurred at the same time economic releases pointed to a deceleration in inflation, what the market was previously anticipating and priced accordingly.  The Fed’s preferred inflation indicator, the Personal Consumption Expenditure (PCI) Deflator was released the same day as the Powell talk, and it showed that inflation had decelerated from the previous month, and on a yearly basis. The last Consumer Price Index (CPI) report also showed that prices were flat over the month and had also decelerated on an annual basis.

Last Friday saw a positive jobs report that some had described as the “Goldilocks” of reports. Payrolls exceeded expectations, with employers adding more than 300,000 jobs.   There were two aspects of the report that were even more favorable and can potentially have stock market implications later this year, thereby reversing the “keep at it” driven market plunge.

The first was the change in the labor force, increasing by a whopping 786,000 in August.  How does this compare to typical monthly changes?   In 30 years, labor force changes greater than that level only occurred 10 times (out of 360 monthly observations).  In the past five years, such a change ranks in the top five, and three of these monthly occurrences were the outsize effects of Covid.   The large jump in the labor force reversed some of the recent declines of this year and moved the economy’s labor force to the highest level of all time.  More about the significance of this later.

The second piece of information from the report was about hourly earnings. Average hourly earnings increased another .3% an hour, but this was less than the consensus and lower than the .47% prior month increase.  Since April, average hourly earnings on a year-over-year basis have been on a steady decline.

Why are these two items important?  Both relate to the price of labor and supply chain issues.   A growing labor force will apply headwinds to average hourly earnings and bring continued relief to supply chain issues, a source of some of the inflationary moves.  Combine this with slowing overall growth, and demand destruction from inflation, and you will see continued declines in the CPI, and these could even accelerate as we enter the last quarter and into next year.  This will have stock market implications to the upside.

The big increase in the labor force should be welcome news for employers.   Even though the economy saw an uptick in the unemployment rate, the labor market remains very tight.  The last JOLTS (Job Openings and Labor Turnover Survey) report showed another increase in job openings.   Job openings now exceed the number of unemployed by about 2.  For every unemployed person, there are 2 job openings available.   Grant it, there may be a mismatch in skills and experience for certain openings, but the large level of openings, relative to unemployed, demonstrates the tightness of the labor market.   This is precisely why the significant pick-up in the labor force was substantial.  The JOLTS report produced a negative market reaction, another example of “good news is bad news” and provided more evidence for the Fed to go with an increase of 75 basis points during their next meeting.

We saw some improvements in the mood of the consumer.  While the Michigan Consumer Sentiment number remains at a historically low level, the index has improved over the past two months, with the latest beating the consensus.  The Consumer Confidence Index, while not at record low levels, also showed improvement from the previous month.   Consumer spending did slow from the prior month but remained slightly positive, and above a consensus of no change.  Cooling inflation, especially through gas prices, will feed improvements in consumer sentiment.

As we mentioned a few weeks ago, the CPI report, at least temporarily, is now the most important economic indicator.   The next report is out September 13, and we should expect another deceleration in price increases.   Depending on the extent of the moderation,  September 13 could be another big day in the equity markets.  Mark your calendars for another wild ride!

By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast

A few weeks ago, we wrote about the tug of war between prices, growth, and profits. We saw some of this play out in the past couple of weeks with the market significance and impact of inflation, through the announcement of the Consumer Price Index (CPI). The consensus was 8.7% on the annual CPI rate, and the release came in at 8.5%. It is a given that 8.5% is significantly above the preferred 2% range of the Fed. However, this was the first time in a while (don’t quote me, but I think all of 2022 and part of 2021) that the actual was less than expected. The month-over-month change was flat or 0%. The core, which removes the cost of food and energy, was also less than expected at 5.9%. The CPI release was met with a strong bounce in the equity markets.

Declining fuel prices and overall moderating prices will have a positive impact on consumer sentiment. We saw this with the latest release of the Michigan Consumer Sentiment survey. This measure of consumer sentiment had seen historic low levels and was dragged down by consumer frustration with inflationary prices. If we go back a few decades, we observe a negative correlation between consumer sentiment and inflation. In a nutshell, when prices are up, sentiment is down. When prices are down, sentiment is up. The last report saw an uptick in consumer sentiment, with the index hitting 55.1, higher than the consensus estimate of 52.5. If we continue to see moderating prices, especially at the pump, look for consumer sentiment to continue to rise. Sentiment will also get a boost from recovering equity prices, excluding the bumpy ride observed last Friday and Monday of this week.

With respect to the consumer, resilience is the word. Retail sales, ex-autos, and fuel came in much higher than expected. These are not adjusted for inflation, but you are not seeing a collapse on the part of the consumer. Overall retail sales were flat from month over month. After stripping out automobiles and fuel, retail sales increased by .72%, and this was more than double the expected amount of .32%.

Manufacturing saw mixed data over the past couple of weeks. The Empire State Manufacturing Index, a measure of manufacturing in the New York area, plummeted from the month prior. The consensus was 5.5 and the actual was -31.3, compared to 11.1 in the prior month. This is only one indicator, and it takes more than one data point to establish a trend. This is one to watch.

While the New York report was dismal, the Philly Fed showed the complete opposite. Manufacturing rebounded from the previous month, with the index showing 6.2, compared to an estimate of -5.0, and a prior reading of -12.3. These regional indicators tend to be volatile from month to month, but we can glean information about the overall trajectory of manufacturing. Industrial production was more consistent with the Philly manufacturing indicator. The Industrial Production Index came in at .6%, beating an expectation of .3%. The manufacturing component of the index was also quite strong, coming in at more than double the consensus estimate.

While some of these indicators are mixed, I’m still in the camp of an overall positive outlook on manufacturing. The inventory-to-sales ratio moved up a bit, given the increase in inventory levels. However, the ratio is still depressed compared to pre-pandemic levels, and significantly under the average over the past 30 years.

The labor market continues to show signs of strength. We saw the blowout jobs report last month with over 500,000 jobs added. The past two weeks saw no significant run-up in unemployment claims. The last week, in fact, saw a decline in weekly claims. New claims for unemployment were at 250,000, well below a number we typically associate with a recession.

Locally, the unemployment rate in Indiana increased by .2% points in July. This was the highest rate increase in the country. The state’s labor force increased by around 15,000 and the number of unemployed increased by about 8,000. So, while we did see an increase in the number of unemployed, the positive aspect of the report was that this was due to labor force growth, which is what we need to see.

What does all this mean? The market was jubilant because inflation may have peaked. If we are indeed past peak inflation, the Fed may have the ammunition it needs to reduce the aggressiveness of rate increases. So, instead of 75 basis points, 50 basis points may now be possible. This Friday will be a big day with an address by Chairman Powell. Lower interest rates are good for valuations, and that’s why we saw the strong equity bounces in the market. If equity valuations hold, combine this with moderating prices, and you will see consumer sentiment start to rebound. All this does not mean that we will escape slower growth, that is coming. With only a few upticks in the unemployment rate, along with more positive consumer sentiment, the Fed may get the soft landing it has been seeking all along. As we close out the year, look for profits to take center stage.

By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast

The big monthly jobs report was released last Friday, and the headline number was out of the ballpark!   About 250,000 jobs were expected but the Bureau of Labor Statistics report showed that more than 500,000 jobs were added in July. Even a number like 250,000 would be considered above average in normal economic times, but 500,000 is through the roof!   The blowout report means that we will likely see another rate increase of ¾% at the next Fed meeting.

Unemployed ranks declined by 242,000, and this was reflected in a drop in the nation’s unemployment rate to 3.5%.   In a nutshell, the national labor market remains very tight.   The labor force showed a decline of 63,000, and the number of workers not in the labor force increased by another 239,000. The labor force participation rate declined. Labor force numbers were a dimmer on an overall positive report. There is a reason why the economy has observed record-breaking levels of investments in machinery and software, and labor force availability is a major driver.

Hiring was the strongest in leisure and hospitality, professional and business services, and health care.   Other notable gains of local interest include 30,000 additional jobs in manufacturing and 21,000 jobs in transportation and warehousing.

The BLS also released the latest employment report for metropolitan areas.  Louisville Metro is now observing steady increases in the metro area labor force.   This had been one of the biggest challenges facing employers, and while challenges do remain, labor force growth is headed in the right direction. The report showed labor force gains from May to June of approximately 6,500 (preliminary estimate, and subject to subsequent revision) for the metro region, which includes Floyd and Clark counties in Southern Indiana. Compared to February 2020, the metro labor force is larger by approximately 13,000 workers.

The number of unemployed in the region declined further. The unemployed ranks dropped by another 1,600 (estimate) to about 24,000. This compares to 37,000 unemployed same time last year.  A growing labor force with a decline in the number of unemployed produced a lower unemployment rate of 3.4%, down from the 3.7% in May.

We are seeing the positive impact of labor force growth on the ability of employers to increase payrolls.  Job growth in Louisville Metro increased by another 6,000, pushing payrolls up by 24,000 over the year. Excluding the abnormal year-over-year changes observed last year, a gain of 24,000 jobs is the highest in the past 30 years.  Total payrolls in Louisville Metro are now at 682,000. In February 2020, metro payrolls were at 680,000.

During the pandemic, the country’s economy saw a massive shift to goods spending. Consumers rushed to improve their homes, buy camping and outdoor sporting equipment, computers and equipment for remote working, sofas, and appliances, etc.  This surge in goods spending could not continue, and we will continue to see a shift away from goods to services.  There is still pent-up demand on the services side, and the consumer is simply directing their spending there.  Gas prices are declining, and this will also support continued growth on the services side, particularly travel. The latest ISM report on services showed additional growth.

On the goods side, there is still pent-up demand in the automobile sector. Inventories relative to sales remain very lean.  Households have delayed automotive purchases due to the lack of available models on the lot, and this is reflected in historically low auto sales levels.  So, while overall goods spending will see a decline, pent-up demand remains in automotive, and this will be a benefit for Louisville and Southern Indiana.  So, when we combine what we are now seeing in services, and the general outlook for automobile manufacturing, the outlook for Louisville Metro remains upbeat.

We will get another round of the Consumer Price Index report this week, and we’ll likely see a moderation in the headline rate. Depending on the magnitude of the decline and the core (CPI minus food and energy) inflation rate, we could see a very strong positive reaction in the equity markets.