Equities finished July in roller coaster fashion on Friday after a surprisingly weak second-quarter Employment Cost Index report. Initially, stocks surged in classic “bad news is good news” fashion before a Federal Reserve official brushed off the report as not having an impact on rate hike timing, which is widely expected in September.
Large-cap issues slumped into the red and never looked back.
In the end, the Dow Jones Industrial Average lost 0.3%, the S&P 500 lost 0.2%, the Nasdaq Composite lost a fraction, and the Russell 2000 gained 0.4%.
Crude oil lost 3.5% to close at $46.82 a barrel, pushing up the ProShares UltraShort Crude Oil (NYSEARCA:SCO) recommended to Edge subscribers to a monthly gain of 56%, after a jump in the U.S. drilling rig count. Gold gained 0.6% to close at $1,094 an ounce.
Defensive utility stocks led the way with a 1% gain while energy stocks were the laggards, down 2.6%. Earnings from Chevron Corporation (NYSE:CVX) and Exxon Mobil Corporation (NYSE:XOM) were terrible — just as expected. Exxon reported a 52% drop in Q2 earnings on a net loss in U.S. upstream business. Chevron also reported weaker-than-expected results. XOM fell 4.6% while CVX lost 4.9%.
The wage data was a big surprise.
It wasn’t supposed to be like this. The unemployment rate has fallen to 5.3%. Survey data shows businesses are preparing to higher wages and are having a harder time finding workers. On various metrics, the labor market is tightening.
The last piece of the economic puzzle — an acceleration of wage inflation — seemed just around the corner. Yet the ECI showed its weakest growth — at 0.2% quarter-over-quarter — in the 33-year history of the report. On an annual basis, wages and salaries are growing at just a 2.1% annual rate.
This dramatic slowdown in wage inflation, which admittedly could be a one-off fluke, flies in the face of other data showing a rapid withdrawal of labor market slack. Weekly jobless claims fell to 255,000 during the week of July 18, the lowest since November 1973. Job opening totaled 5.4 million in May, the highest on record. And the ratio of unemployed workers to job openings was 1.6 in May, the lowest since September 2007.
Moreover, survey data cited by Deutsche Bank shows that companies have been planning to raise worker compensation at a pace that would suggest wages should be growing at closer to a 3% annual rate.
In looking for an explanation for the dissonance, Oxford Economics notes that the ECI was boosted in the first quarter by strong bonus payouts. Still, the slowdown is enough to question whether the Federal Reserve will move ahead with rate hikes at its September policy meeting.
They suggest keeping an eye on the Atlanta Fed’s wage growth tracker for clues as to whether this pay slowdown is actually happening. The measure currently suggests wages are growing at a 3.2% annual rate. Perhaps this explains why St. Louis Fed President James Bullard said on Friday afternoon that he was not concerned about the weak reading in the Q2 ECI report and that the economy is in good enough shape for a possible September rate liftoff.
That’s what pushed stocks lower into the closing bell: Fear the Fed is determined to tighten.
We’ll know more about the situation on the ground next week.
On Monday, we’ll get the personal income and outlays report before the June jobs report is released next Friday. Bank of America Merrill Lynch is looking for payroll growth of 215,000 for July, consistent with the six-month average, with the unemployment rate holding at 5.3%.
Looking back at the June report, there was a sharp decline in the participation rate (which pushed down the unemployment rate) as well as a slowdown in average hourly earnings. They expect both to reverse in the July data.
The second-quarter earnings season will also continue to roll out. According to FactSet data, with 354 S&P 500 companies reporting, the blended earnings growth rate is expected to be -1.3% — on track for the first outright decline in profitability since 2012 and the largest decline since 2009.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. Free two- and four-week trial offers have been extended to InvestorPlace readers.
