Labor market data show easing … tech layoffs are surging … what does history tell us about how high the unemployment rate might go? … are Q4 earnings estimates accurate?
The labor market is cooling…Last Thursday, jobless claims came in at 228,000, which was above the government estimate of 198,000 new claims.It also marked the ninth consecutive week of jobless claims topping 200,000.From MarketWatch:
The number of people applying for unemployment benefits is one of the best barometers of whether the economy is getting better or worse. While new unemployment filings are still quite low, they’ve shown a marked increase in the past two months…Wall Street is watching jobless benefits closely because it’s one of the first indicators to emit warning signs when the U.S. is headed toward recession.The low but rising level of claims suggests the economy might be getting closer to the danger zone.
We received further confirmation of this labor market weakening on Friday, with the latest payrolls report.Hiring in the U.S. eased slightly as employers added 236,000 workers, which was less than the Dow Jones estimate for 238,000 and below February’s upwardly revised number of 326,000.Here’s CNBC with the latest on wage growth from the same payroll report, which the Fed also watches very closely:
Along with the payroll gains came a 0.3% increase in average hourly earnings, pushing the 12-month increase to 4.2%, the lowest level since June 2021. The average work week edged lower to 34.4 hours.
This weakening is what Federal Reserve Chairman Jerome Powell wants to see
To explain, here’s CNBC from after the Fed’s March FOMC meeting:
The reason for the continued inflation focus, more than anything else, was always in plain sight: the job market is still too hot and wage growth, while cooling, hasn’t cooled enough for comfort.Fed Chair Powell’s focus on the labor market has been consistent in the months leading up to Wednesday’s rate hike decision, and when asked at the post-FOMC meeting press conference whether the central bank considered a pause in rate hikes given the concerns about global financial system fragility, his initial response went straight to the labor market.“Labor market data came in stronger than expected,” Powell said.
Given this focus on the labor market and wage growth, last week’s news has to be encouraging to Powell. These data will help support the case for a pause in interest rate hikes when the Fed meets next in early May.That said, as we’ve noted in recent Digests, we’re increasingly concerned that economic fallout is already baked into the cake at this point due to the Fed’s interest rate hikes so far. The danger is that the labor market “crack” we’re beginning to see – which the Fed wants – could snowball into a labor market “shattering.”
On the topic of the weakening labor market, the job losses in the tech sector are raising an eyebrow
Let’s jump straight to CNBC:
Companies announced nearly 90,000 layoffs in March, a sharp step up from the previous month and a giant acceleration from a year ago, outplacement firm Challenger, Gray & Christmas reported Thursday…The damage was especially bad in tech, which has announced 102,391 cuts so far in 2023. That’s a staggering increase of 38,487% from a year ago and good for 38% of all staff reductions.Tech already has cut 5% more than for all of 2022, according to the report, and is on pace to eclipse 2001, the worst year ever amid the dot-com bust.
Andrew Challenger, senior vice president of Challenger, Gray & Christmas, said that given the continuation of rate hikes and corporate America’s efforts to rein in costs, he expects more large-scale layoffs.While the tech sector has been hit the hardest by layoffs, financial companies are getting hit too. With 30,635 job losses this year, that represents a 419% increase from the first quarter of 2022.Stepping back, how significant are these layoffs?After all, a fair pushback is “yes, the percentage of layoffs is increasing at what appears to be a frightening speed, but overall, the absolute number of layoffs remains relatively low, which distorts the percentage gains.”That’s true.But the perspective we should consider isn’t so much “we’re starting from a low unemployment number so we’re okay” but more so “can the Fed stop the low unemployment number from snowballing into an unemployment disaster?”
Increasing the unemployment rate just-enough-but-not-too-much is a daunting challenge
Imagine a seesaw with one end resting on the ground. You’re standing on that end, slowing walking toward the elevated end. Your goal is to balance the seesaw perfectly, without accidentally tipping it in the opposite direction.If you tried this as a kid, you likely recall that once momentum builds in the opposite direction, it can be difficult to stop. Before you know it, the seesaw has inverted.The Fed faces a similar test with how its rate hikes impact the labor market. What does this look like historically?Below, we look at the U.S. unemployment rate dating back to the late-1960s. This is in red.We’ll also show the Fed Funds Effective Rate in blue.There are two things to notice…First, when the Fed Funds Effective rate (in blue) surges to a peak (usually topping out above the unemployment rate in red), we nearly always see a related jump in the unemployment rate in the ensuing months.It was more exaggerated in the 70s and early 80s, but it remains true in the last two decades.Second, every single time the unemployment rate (in red) has begun from a level under 4%, the ensuing jump in the unemployment figure has taken the unemployment rate up to 6%+, at a minimum.There is no example of the Fed being able to just nudge the unemployment rate up from, say, 3.6% to 4.2% or 4.8% at which point it hits a rough equilibrium then cools.The closest we have to that is when unemployment started at 3.4% in 1969 and then jumped to 6.1% in 1970. But even then, after the unemployment rate fell up until 1973, it then spiked to 9% by 1975.(The period from 2000 – 2003 saw inflation top out at 6.3%.)Bottom line: Unemployment tends to take the stairs down, but the elevator up.Here’s how this looks.
As you can see at the right edge of this chart, the Fed Funds Effective rate has recently topped the unemployment rate. If history is a guide, we’re likely to see an unemployment spike.
But what about the Fed being able to thread the needle? What about the whole “soft landing” outcome?
Here’s Visual Capitalist:
…Some believe that aggressive rate hikes by the Fed can either cause a recession, or make them worse.This is supported by recent research, which found that since 1950, central banks have been unable to slow inflation without a recession occurring shortly after.
Despite this, the Congressional Budget Office (CBO) estimates we’ll enjoy what amounts to a rosy outcome, all things considered:
Reflecting the expected slowdown in economic growth, the overall rate of unemployment is projected to rise from 3.6 percent in the fourth quarter of 2022 to 5.1 percent by the end of 2023…Thereafter, the unemployment rate is projected to decline gradually beginning in the second quarter of 2024, falling to 4.5 percent by the end of 2027.
If this scenario plays out, it will be the first time ever.I’m about to show you the same unemployment chart we just looked at. Only this time, we’ll take out the Federal Funds Effective Rate.Plus, I’ll add a green trendline at 3.5% (where we are today) and a red trendline at 5.1% (where the CBO says unemployment will peak).In the last 50+ years, there is not one example of the unemployment rate mirroring the CBO’s estimation.
Again, the closest to such an outcome is 1969 – 1970, when the unemployment rate temporarily topped out at 6.1%.
To be fair, if the unemployment does climb above the Congressional Budget Office’s estimate, it doesn’t necessarily mean a brutal recession
We certainly hope that’s the case.But as investors, we need to engage in second-order thinking…The main issue isn’t the unemployment rate. The concern is how the unemployment rate will impact consumer spending… which impacts corporate earnings… then stock valuations… then stock prices… then your portfolio value.Let’s say unemployment rises only to 5.1% this year as the CBO suggests. As CBS News reports “a jump in unemployment of that size would imply that hundreds of thousands of people who are currently employed would lose their jobs.”It seems logical to assume that if “hundreds of thousands of people” lose their jobs by the end of this year, it will mean less spending in the U.S. economy rather than more. By extension, that would suggest less corporate profit rather than more.But if we look at FactSet, which is the go-to earnings data analytics company, it reports that analysts are estimating earnings growth of 9.3% by Q4 of this year.Now, it’s certainly possible that these higher earnings could be coming thanks to slashed corporate headcount from all the layoffs. But the inconsistency between “hundreds of thousands of people” out of work by the end of December and 9.3% earnings growth between October and December catches my eye.However, perhaps this time the Fed will nail it and be able to engineer such a happy ending. We’re crossing fingers they can.Have a good evening,
Jeff Remsburg
