The U.S. labor market, a crucial pillar of economic stability, may be showing signs of potential instability, which could spell trouble for the stock market. Recent trends suggest a concerning shift, with the unemployment rate edging up, raising alarms among investors and analysts.
Kevin Gordon, a senior investment strategist at Schwab, highlighted the recent increase in unemployment to 4% in May, following a two-year period of lower rates. “Once you do start to see it creep up, it’s pretty hard to stuff that back into the bottle,” Gordon remarked, emphasizing the difficulty of reversing rising unemployment trends once they begin.
The current economic narrative is becoming increasingly dominated by concerns over a potentially rapid deterioration in the labor market. While the Federal Reserve has been maintaining higher interest rates to manage inflation and economic growth, the prospect of a weakening job market is causing apprehension. The fear is that the Fed might need to lower rates to support a struggling economy, rather than to achieve a smooth economic landing.
In the first half of 2024, job creation averaged 250,000 per month, according to Bankrate’s senior economic analyst, Mark Hamrick. However, Hamrick anticipates the upcoming June employment report to show stable unemployment but weaker hiring. “If either of these key metrics fails to match expectations, it could raise concerns about the risk of a more significant slowdown in the job market and beyond,” Hamrick noted.
Despite these concerns, the economy has managed to navigate the Fed’s prolonged period of higher interest rates without significant issues. The S&P 500 index (SPX) recorded its best first-half performance in an election year in nearly five decades, providing a positive outlook for July, which historically has been favorable for equities.
However, there are varying perspectives within the Federal Reserve regarding the labor market’s resilience. The ratio of job openings per person has declined to 1.2 from a peak of 2 in 2022, indicating a cooling in the labor demand. Roosevelt Bowman, a senior investment strategist at Bernstein Private Wealth Management, pointed out the evolving views within the Fed, stating, “If you rewind three months ago, it was a unified front. I do think the unemployment rate is going to be really important to focus on.”
Investors are closely monitoring the labor market, even though many remain optimistic about avoiding a recession this year. Stocks are near record highs, and credit spreads are historically tight, suggesting a lack of immediate concern about economic downturns. However, caution persists among some analysts. Luke Tilley, chief economist at Wilmington Trust, expressed wariness about stock valuations despite his investment committee’s inclination to add equities, particularly U.S. large-caps. He believes there is value in the underperforming sectors of the S&P 500 and anticipates a broadening of the rally as economic growth slows and inflation cools, potentially paving the way for rate cuts.
Tilley also reflected on historical precedents, noting that it took about 18 months for the economy to falter after interest rates peaked in 2006. While he does not see strong similarities between the current situation and the onset of the 2007-2008 recession, he emphasized the importance of considering the delayed effects of a rate-hiking cycle.
On the other hand, Matt Stucky, chief portfolio manager for equities at Northwestern Mutual Wealth Management Company, expressed less optimism. He highlighted the discrepancy between Wall Street’s forecasts of double-digit earnings growth for the stock market and the reality of weaker economic data, rising consumer delinquencies, and the Fed’s steadfast policy rate at its highest level in two decades. FactSet’s recent projection of 11.3% annual growth in S&P 500 earnings for 2024 and 14.5% for the following year seems overly optimistic to Stucky, given the Fed’s intention to slow the economy. He advised investors to prepare their portfolios for a mild recession within the next 12 to 18 months, warning that risks are increasing.
As of the end of June, the stock market showed mixed results. The Dow Jones Industrial Average (DJIA) rose by 1.1% in June, the S&P 500 increased by 3.5%, and the Nasdaq Composite (COMP) advanced by 6%, according to FactSet. The Dow finished the quarter lower, while the S&P 500 and Nasdaq experienced their third consecutive quarter of gains.
Key Takeaways:
- Rising Unemployment: The unemployment rate increased to 4% in May, causing concern among investors and analysts.
- Labor Market Concerns: A deteriorating job market could prompt the Federal Reserve to lower rates to support the economy.
- Economic Data: Job creation averaged 250,000 per month in the first half of 2024, but weaker hiring is expected.
- Stock Market Performance: The S&P 500 index had a strong first half of the year, with positive outlooks for July.
- Diverse Fed Views: The Federal Reserve’s perspectives on the labor market are becoming more varied as job openings decline.
Conclusion
The U.S. labor market’s recent trends indicate potential instability, posing a threat to the stock market’s current strength. While the Federal Reserve continues to manage interest rates to balance economic growth and inflation, rising unemployment and weaker hiring raise concerns about a significant economic slowdown. Investors must remain vigilant and consider the potential for a mild recession in the near future, adjusting their portfolios accordingly.
