VTI - April Jobs Report Keeps Stock Market Bulls In Control

2023-05-05 15:53:00 ET

Summary

• The strong April jobs report confirms economy remains resilient.
• The mix of economic data likely keeps the Fed on track to hold rates steady at the next FOMC.
• We view the backdrop as positive for stocks and the S&P 500.

The April payrolls report showed the U.S. economy added 253k jobs , well ahead of the 178k estimate. At the same time, the prior March jobs data was revised lower to 165K from the initial 236K print, sort of making the net effect between the two months a wash against the consensus. The unemployment rate still ticked lower to 3.4%, reflective of a still-tight labor market.

The takeaway here for us is that the report goes a long way to brush aside concerns of a looming recession or fears of collapsing economic conditions. Indeed, it's very impressive that amid all the macro headwinds, the economy has remained resilient.

In our view, the positive dynamics of a strong jobs market at this stage in the cycle far outweigh the implications for inflationary trends or the next steps in Fed policy. More people working is good news as it relates to consumer spending, which ultimately translates into the demand side of stronger corporate earnings. This line of thinking helps explains the stock market strength in recent months and the latest rally from the payrolls report.

The path we see continues to be toward a "soft-landing" scenario in the economy which remains the cornerstone in the bullish case for stocks. With the Fed on track to hold rates steady, ending its historic tightening cycle, the ability of the U.S. to avert a deep recession while inflation trends lower can work to support the stock market going forward.

Fed Is Done With Rate Hikes

From the latest Fed Meeting, the messaging by Chairman Powell suggests we may have just seen the last rate hike in this cycle. In our view, the latest payrolls report, while technically coming in stronger than expected, does not undermine that option for the Fed at the June FOMC.

According to the CME FedWatch Tool , which incorporates rates futures to arrive at an implied market probability for the direction of policy, the market is pricing in a 90% chance the Fed will maintain the Fed Funds Rate at 5.25% as representing a "pause."

The understanding is that further rate hikes are unnecessary for inflation to continue stabilizing lower and trend toward the official 2% target down the line. This considers that the transmission of recent hikes over the last several months is still working through the economy, with a new policy stance also justified by recent inflation data.

The March PCE Price Index declined to 4.2%, down from 5.1% in February and 7% at its peak last year. Keep in mind that this was accomplished during a period when the U.S. economy added nearly 3 million jobs cumulatively over the past year.

Our interpretation is that the labor market and wages are simply not the culprits to why the inflation remains elevated, particularly at this stage in the cycle. This is a view also shared by Fed Chairman Powell, which directly addresses this dynamic during the press conference .

Responding to a question regarding whether the Fed is concerned about wage growth trends, Powell made a point to confirm he does not believe wages are the "principal driver of inflation" and is instead likely to observe trends across several employment indicators. On this point, the April average hourly wages ticked higher with a 4.4% annual growth rate, from 4.3% in March, but this figure is also down from a peak closer to 6% last year.

What's more important is the expectation that conditions still slow down into the second half of the year. With recurring headlines of high-profile companies moving forward with layoffs, alongside the question marks in the financial system, all indications are that cooler wage growth from here would work to further ease inflationary pressures.

On the other hand, we don't see a good reason for inflation to reaccelerate from here, while there is likely more room for a surprise lower. Reports of declining used car prices , for example, for the first time this year are favorable developments.

If we have a controversial point, it will be that we don't see aggressive rate cuts as likely, or necessary this year even in a bullish case for stocks. This is apparently a contrarian view compared to a current market-implied probability of 72% for the Fed Funds Rate to end 2023 at 4.5% or lower. In our view, the Fed would only move to cut rates if economic indicators materially weakened, which would be perceived as a negative environment for risk assets.

We would be more in the camp where stronger-than-expected economic data keeps the Fed on pause while waiting until Q4 to consider a rate cut with more confidence inflation is converging toward the target level. By 2024, a backdrop of lower and stable inflation, while interest rates drop into a rebounding economy, is the path for the next bull market.

Stock Market Bulls In Control

With the S&P 500 (SP500) up more than 8% this year, we expect more upside. The latest round of macro data including the April payroll report, supports a bullish positioning. The soft landing in the economy scenario is still on the table, which can be positive for equities with room for SPX to rally into a 52-week high above $4300 over the near term.

The trend this earnings season has been the string of companies surprising with stronger-than-expected results. The theme of companies generating financial efficiencies through cost-cutting efforts and pricing initiatives in support of margins has been a positive development that can continue to benefit earnings going forward.

On the downside, the biggest risk would be for a more concerning deterioration of economic conditions. A payrolls report where the economy loses several hundred thousand jobs and the unemployment rate spikes high would have more negative implications for corporate earnings. Inflation data is also a monitoring point, with the potential of a sharp rebound in commodity and energy prices forcing a reassessment. Overall, as long as SPX remains above ~$3950, the bulls are in control.

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