QVMM - Why A Strong U.S. Jobs Market May Weigh On Canadian Equities
- With so much negativity baked in, it may have been inevitable that markets would rebound.
- The strong U.S. jobs numbers highlight the challenges in reading the economy.
- As the Fed hikes rates, it's not just slowing the economy, it's building back its credibility.
The U.S. jobs market has been defying recession fears, suggesting to some the Fed is likely to continue hiking rates to fight inflation. Greg Bonnell speaks with Michael O'Brien, Head of Core Canadian Equities at TD Asset Management, about the possible impact on Canadian stocks.
Transcript
Greg Bonnell: We have seen a bit of a summertime rally in stocks. The broader markets are in the green again today. But our featured guest today says last week's jobs report could put a cap on how high these stocks can run going forward. Michael O'Brien, portfolio manager at TD Asset Management joins us now. Great to have you back on the program. Let's make sense of all this, because I was trying to make sense of the market reaction to this meaning this and this meaning this, good news, bad news. What's the equation we're looking at now?
Michael O'Brien: Well, I think we went through a period just the last few weeks where good news was good news and bad news was good news. There's so much pessimism...
Greg Bonnell: It's all good news.
Michael O'Brien: So much pessimism has been baked into the market that I think a lot of these stocks, especially those big, strong, growthy technology stocks south of the border were really primed for a recovery. And we got that over the last, what, two, three, or four weeks. It's been a pretty nice run. I think that the reason we saw this setup transpire partly it was expectations had gotten pretty pessimistic. But also, I think a narrative crept into the market that maybe the Federal Reserve was getting close to having done enough. Maybe they won't need to keep raising rates as aggressively as they have. And, obviously, if you get a signal that the Federal Reserve is going to slow down or pivot in the vernacular to a less aggressive rate hike cycle, that's very positive for stock valuations. So I think that's what was underpinning this recent rally. And so the reason I was saying last week's payrolls report was quite significant is it just gave us a real-world data point that whoa, don't get ahead of yourselves here. The economy is still in pretty strong shape.
Greg Bonnell: Yeah, this idea of the pivot, right? And you said the hopes, almost feels like hopes and dreams among some investors or some of that. Don't worry, we're almost done. There's going to be a pivot. Then you get this really strong jobs report. This has got to change some minds about where the Fed is headed.
Michael O'Brien: Well, I think I don't know if it changed -- well, it certainly changed some minds. But I think what it did was it probably solidified the thinking of the Federal Reserve itself, where the Fed all along has been communicating that they feel they can raise rates pretty aggressively because the economy coming into this rate hike cycle was in fundamentally good shape. And we got that evidence on Friday, that the labor market south of the border is still drum tight. So, to me, that just says there's going to be more rate hikes. Maybe we get 75 basis points in September. So we haven't quite turned that corner yet. So I think the market got a bit ahead of itself these last few weeks.
Greg Bonnell: What about this argument that the markets are forward-looking instruments? So yes, in anticipation of the continued strength of the US economy, the continued rate hikes we're going to see in the face of strong inflation, that all of that got priced out and it's behind us again. Again, that's the optimist's take on everything. Don't worry about it. The equity market is a forward-looking instrument. Sometimes I feel like I'm just still trying to figure out what exactly the equity market is trying to tell me about the current situation, whether it even knows about the current situation.
Michael O'Brien: Well, you're absolutely right. The market is forward-looking. The problem is the market doesn't have a crystal ball. So sometimes they get it right and sometimes they get it wrong. We're all responding to these data points in real-time. And the market, again, with the setup coming into this, which was pretty bleak and valuations have come down quite a long way, it wasn't an unreasonable thing to take a bit more optimistic look. If you're convinced the glass is totally full and now maybe it's half empty, why not give it a shot? So I think that was part of it. The setup coming in was very negative. I think one thing the market is increasingly convinced of is that the Fed, the US the Federal Reserve, and I think by extension the Bank of Canada on this side of the border, that they do still have their inflation-fighting credentials intact. I think if you look at the action of the bond market especially, but also the stock market, the way that these longer-duration stocks have really picked up, is OK, we had a bit of a scare earlier in the year. But now we've listened to what the central bankers are saying. And we've observed what they've actually done. And yeah, we get it. They are fighting inflation. They aren't going to let inflation get away. They aren't going to let us go back to the '70s. We're not going to have a Paul Volcker type of moment. So I think that's very good in terms of re-establishing the credibility of the central banks. The problem is that credibility comes at a cost. And the cost is in order to bring inflation back to a more palatable level of around 2%, there's a lot of wood to chop. And particularly what we need to see is a softer labor market, which implies slower growth. And slower growth typically implies lower earnings. So it's a bit of a be careful what you wish for because in order to re-establish their inflation credentials, they are going to have to slow down the economy a bit. And the real trick going forward is can they pull off that soft landing that everybody aspires to, where you don't have a significant downturn? Or do they overshoot and force us into something a little uglier?
Greg Bonnell: So we haven't seen that softening of the labor markets south of the border. Canada's job prints have been a bit strange in terms of the tightness of the market, but also the fact that we're losing positions. You mentioned the Bank of Canada. Do they have as clear a road ahead as the US Federal Reserve has with its economic indicators? Or are things a bit dicier here?
Michael O'Brien: It's a little more mixed in Canada, because like you say, the last two job reports, quite the opposite of what we saw south of the border. The last two job reports in Canada were surprisingly soft. Canada actually lost jobs in June and July. And so now the Canadian employment report is notoriously volatile. So take everything with a grain of salt. But two consecutive months of negative job growth. There's got to be some signal in there. So I think in that respect, that's got to send a bit of a message to the Bank of Canada, that, look, the economy is responding to a pretty aggressive rate hike cycle that we've put in place already. So I'm sure that gives them some pause. The other side of it, though, is that inflation is still very high. And as you mentioned in that same employment report, wage growth is running north of 5%, which is a pretty healthy level. And the participation rate, which gives you an idea of how much slack is in the labor force, the participation rate fell again, which is not a good development. So that wasn't the type of employment report the Bank of Canada would want to see, because on the one hand, the economy does appear to be responding fairly quickly to these interest rate increases. On the other hand, there's still signals that more needs to be done because the labor market, despite these job losses, is still too strong.
Greg Bonnell: If we got to a point in this country where the Bank of Canada had justification based on the data to take a different path than the US Federal Reserve, could they at this point, coming out of the pandemic, trying to get inflation under control? Is everyone just sort of in lockstep with the Fed and what the Fed does?
Michael O'Brien: Well, obviously, the Fed is the 800-pound gorilla on the global central banking scene. But to a certain extent, each central bank can chart its own path. If you look at the Bank of Canada's situation, they were actually earlier and harder into this rate cycle. They moved quicker than the Federal Reserve did. And we've had that long-standing Bank of Canada policy of targeting a 1% to 3% inflation rate, which goes right back to the early '90s. And so I think the Bank of Canada comes into this with their inflation credentials well intact. And I think them moving quickly, moving aggressively, it just reaffirms that the Bank of Canada is on the case. And so I think that does give them flexibility if the data requires. It does give them a chance to maybe diverge a little bit from the path the US is on. But we'll see where we end up. I think there won't be a whole lot of surprises on the monetary policy front for the next couple of meetings. As we get in closer to year-end, maybe that's where we start to see some of those divergences appear if these trends continue.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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Why A Strong U.S. Jobs Market May Weigh On Canadian Equities