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!