Stocks staged a sharp two-day rally on Thursday and Friday as interest rates plateaued and economic data showed continued strength in the service sector. The retreat in long bond yields Friday, after an extended rise, gave particular strength to the technology group.
At the start of the pandemic demand for services fell off the cliff. Even when quarantine ended, collectively we were reluctant to go back to work, go to weddings, or travel. Restaurant seating outside was preferred. In many cases, indoor seating wasn’t even allowed. Stuck at home, literally, or just out for work or schooling, we loaded up on groceries, PCs, and videogames. Outdoor activities like golf and biking led to a surge of demand; outdoor dining meant a boom in the sale of grills. That slowly changed. By last year, stadiums were full once again. Family gatherings made up for lost time. We stopped cooking and ate out. Airplanes, hotels, and Disney World were packed. That trend is still in place, although judging from rising levels of consumer debt, some slowdown should be anticipated.
Just as demand for PCs, bikes and golf clubs couldn’t be sustained near peak levels, it is logical that demand for many of the services still enjoying boom times will level off soon. But until it does, labor will remain in short supply. Over 30% of jobs are concentrated in restaurants, hospitality and health care, and 2.5% of jobs are concentrated in the tech sector. For every employee that Amazon# is laying off, Kroger is adding just as many or more. Of course, the new McDonald’s cook makes a lot less than the software engineer whose job may be in jeopardy. A lot of the Amazon layoffs are occurring in the distribution centers, not in its software development labs. Thus, restaurants still need waiters, while manufacturers are not hiring to any great extent.
Thus, the economy still sends mixed signals. For the past two weeks, retailers have been reporting year-end results. For the most part, the fourth quarter was OK, not great but not so bad either. However, forward guidance varied from tempered to downright weak. Almost every retailer forecasted slower demand growth for the next several months. On the other hand, as supply chain snarls unravel, there has been a lot of pent-up demand released. Companies like Grainger, which sells thousands of different parts and products to the industrial sector, are feeling that catch-up boom. Auto dealers are still restocking even as the pace of demand for new cars seems to be leveling off. Lower-grade car loan defaults are spiking, an obvious sign of stress. How long before discounting returns to pre-pandemic levels?
If you yell loudly at the right place, you can hear an echo. Often it reverberates in successively softer voices. That is similar to the way the economy has been recovering. Demand spikes, then there’s a correction. Then there is another smaller wave, etc. The economy does the same. At the start, there was a sharp increase in demand for a few products. Certain merchants, like Home Depot# and Best Buy#, benefitted from scale. In some cases, they were the only game in town, but as others reopened, and as demand for appliances and computers waned, it became their turn to suffer. That situation will change again. PC sales, over time, are likely to mirror the economy. They aren’t going to rise 15% as they did in 2021, nor will they fall 20%+ as they did in 2022. The amplitude of change will slow, but until that all washes out, there will continue to be a flow of mixed messages. The pandemic created very few new paradigms. Perhaps there will be some more working from home and an increased use of masks in times of peak respiratory disease. Today’s surge in travel and dining out will calm down. If we do endure a recession, and that remains uncertain, you can count on the fact that those suffering will eat home more and travel less.
Which brings us back to the equilibrium phase I wrote about last week. Markets are pricing in three more Fed Funds rate increases between now and mid-year. Could there be more? Sure, but we can’t make that determination today and neither can markets. The most sensitive economic data of the moment concerns employment, wages, and inflation. Friday’s jobs report is important. So is next week’s CPI report, and I can say the same for all similar reports between now and the June Fed meeting.
It is logical to expect the shelter component of inflation to start to indicate lower inflation in the months ahead. I don’t know if that will start with this month’s report or not. It isn’t that important because we all know it is coming. What is important are labor trends, both for employment headcount and wages. Real time anecdotal data shows a slower labor market than recent Federal statistics indicate. At the same time, services inflation remains stubbornly high and isn’t receding. That will have to change for the Fed to consider any relaxation. The strong February reports of January economic activity and inflation have some pundits and Fed officials talking of a peak Fed Funds rate of 6%+. That isn’t a consensus yet, and it isn’t priced into markets, but if labor gains return to 200,000 or less and the soft shelter inflation numbers flow through, it is likely that the hawkish tones of recent weeks will calm down.
Markets, being forward looking, will react to changes in consensus. Earnings season is largely over and won’t be a factor again until April. That places unusual importance on the labor and inflation numbers to come over the next few weeks. Friday’s jobs numbers will be the first major release this month. Last month, the employer survey showed a shocking gain of over 500,000 jobs, although the less followed household survey showed little change. Forecasts for February are all over the place, suggesting a more pronounced reaction when the data is release. Next week’s CPI report will be the next huge number. All January inflation numbers were higher than expected after several months of slowing. Another hot number in February wouldn’t be received well, but once again, consensus is diverse.
Thus, the best way to describe the macro backdrop is to call it sideways and volatile, not unusual for a transitional moment. Both inflation and economic growth are slowing. Neither, according to January data, is slowing fast enough. February data won’t create a new trend, but it can give us a sense of how long and how tough the fight to defeat inflation will be. We’ll be watching, and reacting.
Today, Alan Greenspan turns 97.
James M. Meyer, CFA 610-260-2220