Key Points From Last Week

  • The labor market appears to be regaining its strength. Job openings increased to 8.1 million in November. December’s nonfarm payroll gains beat expectations, up 256,000. The biggest job gains were found in health care, leisure and hospitality, and retail trade. The unemployment rate also fell to 4.1%. It has been impressively stable after rising earlier in 2024, holding at either 4.1% or 4.2% for seven straight months.
  • The services sector (which accounts for nearly half of all economic activity) is still firing on all cylinders. The ISM Services Purchasing Managers’ Index rose further into expansion territory at 54.1. That strength does come with a price, however, as the prices paid component also rose to a two-year high.
  • Economic strength appears to be setting the table for another pause from the Federal Reserve (Fed). Treasury yields continue to rise in response, with the 10-year U.S. Treasury Note yield making its way toward the Q3 2023 high of nearly 5%.
  • The backup in rates is causing discomfort in equity markets, particularly for rate-sensitive cohorts like small caps, financials, real estate, and homebuilders.

What’s on Our Minds This Week

Good News Can’t Be Bad News Forever

Equity markets started the week with a note of caution. Higher interest rates have been weighing on equity prices for about a month. The post-election surge has been mostly given back. The S&P 500 index is 5% off its high from a few weeks ago.

However, it is important to recognize that interest rates are moving higher mostly on the back of a U.S. economy that is coming in stronger than expected. Last week’s labor report showed that consumers are employed, which will allow them to continue to spend and power the U.S. economy, the engine of the global economy. As a reminder, consumption makes up 68% of U.S. gross domestic product.

But the rise in rates is not entirely about a stronger economy. Recent inflation reports have shown a stickiness in the 2.5%–3.0% range, above the Fed’s target of 2.0%. Sticky inflation needs to be distinguished from a new wave of rising inflation, which might trigger the Fed to raise rates. So far, there is no sign of that. However, important inflation readings will be released this week. It is worth noting that average hourly earnings came in below expectations in Friday’s labor report, potentially signaling decent Consumer Price Index and Producer Price Index figures this week. At this point, the equity markets have probably priced in the expected readings from these metrics. Hotter-than-expected numbers may not be priced in, however.

It is important to recognize that since the Fed started raising interest rates from the zero bound almost three years ago, changes in interest rate expectations have required adjustments in equity prices. These adjustments, which have not always qualified as a full correction (>10% drawdown), are normally relatively short (~1 month duration). These moments in equity markets usually feel like something worse. With a strong economy and rising sentiment measures, it seems unlikely that we are headed for a recession and something worse than an equity market correction. Of course, all can change when the new administration takes over the White House on January 20. We shall see.

For now, beware of succumbing to the good-news-is-bad-news paradigm. These moments seldom last long. When the current stretch is through, we are likely to be happy with a full employment picture and the implications that has for corporate profits.

Sources: FRED, Bureau of Labor Statistics, FactSet. Past performance does not guarantee future results.

Please read important disclosures here.