Market Commentary from Atticus Wealth Management
February 2023 – 1st Quarter
Only a few weeks into 2023, news headlines have sparked concern among some investors. Markets have been on edge watching Congress’s protracted House Speaker battle and hearing more layoff announcements across industries. Despite these challenges, the pivotal issue remains whether the Fed will cause a recession in 2023, even if most economists believe it would be shallow. Slow or negative growth is already impacting profit forecasts across industries and could place further pressure on valuations. What should long-term investors be watching to focus on the big picture? Answer: The labor market and its impact on Fed policy.
Labor markets are pivotal to the Fed’s reaction function. The first jobs report of the year set the stage for this debate by showing that a healthy 223,000 jobs were added in December, bringing the unemployment rate down to only 3.5%, tying the lowest level since the 1960s. With December’s final number in, the economy added 4.5 million new jobs in 2022. While this doesn’t compare to the 6.7 million jobs created in 2021 as the economy bounced back from the pandemic, it is far above the 2.3 million and 2 million jobs added in 2018 and 2019, respectively. While a strong labor market appears healthy for the US economy, it presents a problem for the Fed as a tight labor market has historically contributed to higher inflation.
1 Breaking Down the Strong Labor Market
The most impactful data point within the labor market is the pace at which wages rise due to the tight link between wages and inflation. While higher pay for workers is undoubtedly good news for households and individuals, markets often view this differently. To Wall Street, wages that rise too quickly can spark “too much” consumer spending and spur inflation. Case in point: the surge in consumer demand fueled by excessive pandemic-related stimulus drove shortages and supply chain disruptions resulting in decades-high inflation.
Further, since wages represent costs to employers, upward pressure on pay results in inflation for businesses and corporations. As workers get paid more, companies feel the pinch to profit margins. As a result, businesses feel incentivized to raise prices to protect their margins, which pushes inflation higher and, in turn, motivates workers to ask for even higher wages. Economists call this dynamic a wage-price spiral, which is difficult to reverse.
But, harking back to the December job report, investors took the fact that wage gains slowed in December as a positive sign. Wage growth decelerated to 4.6% for the private sector and 5.0% for production and non-supervisory workers (i.e., typically hourly workers). This deceleration was better than economists had expected and represented a healthy deceleration from the 5.6% private sector peak last March. Slowing wage growth is consistent with other decreases in inflation over the previous few months, from energy prices to shelter costs.
As further evidence that wage growth may be slowing, the Employment Cost Index compiled by the Bureau of Labor Statistics suggests that salaries and wages decelerated from 5.7% last June to 5.2% in September. The Atlanta Fed Wage Tracker has also declined from a peak of 6.7% in July and August to 6.4% in November. While these moves may not be large, they are all in the right direction.
Investors, encouraged by the recent wage data, pushed markets higher since lower wage pressures corresponds to slowing inflation and, thus, a slowing of Fed rate hikes. While positive, it’s essential that investors do not get ahead of themselves. After all, hope that the Fed will begin to back off its aggressive policies drove numerous market swings last year. But hope is not a sound investment approach, and these rallies ultimately disappointed investors as the Fed reiterated its commitment to keeping rates higher for longer.
Considering the various dynamics affecting the market, economists forecast that growth could be flat for the year, with GDP slightly negative in the second quarter and positive again in the fourth. These projections are very sensitive to the Fed, inflation, and interest rates. Suppose inflation improves faster than expected, and the Fed is convinced to pause sooner or at a lower rate. In that case, markets and the economy might surprise to the upside. But, until that happens, investors should follow the long-term trends in the data and resist getting caught up in month-to-month moves.
2 So, what does Atticus’ Investment Committee expect for 2023?
The Fed’s new standard of waiting for “substantially more evidence” of inflation moderating implies that the liquidity cycle downturn coupled with quantitative tightening that started in 2022 may extend deep into 2023. But, despite this, there may be a period of relative peace in the first half of 2023. Why do we believe this? Because Atticus’ Investment Committee does not see the Fed’s quantitative tightening program affecting liquidity materially from its current levels between now and the end of Q2 for two reasons. First, we expect an accelerated drain from the Treasury General Account. Second, we expect a drain from the Fed’s Reverse Repo Facility due to increased T-Bill issuance as a cash management technique ahead of the debt ceiling showdown this Summer. All of which should work to stabilize markets, for now.
But that doesn’t mean investors are out of the woods quite yet. The Fed’s incorporation of the tight labor market into its reaction function will likely cause the Fed to over tighten into 2023 with no rate cuts or liquidity provisions until 2024. Given this dynamic, investors should remain cautious and well-diversified with attractive fixed income to offset any economic weakness created by Fed policy. Our Investment Committee believes in continuing to overweight defensive equities and maintaining a degree of cash as the probability of a Fed-created recession rises in the back half of 2023.
THE VIEW FROM THE TOP
Market Commentary from Atticus Wealth Management
February 2023 – 1st Quarter
Only a few weeks into 2023, news headlines have sparked concern among some investors. Markets have been on edge watching Congress’s protracted House Speaker battle and hearing more layoff announcements across industries. Despite these challenges, the pivotal issue remains whether the Fed will cause a recession in 2023, even if most economists believe it would be shallow. Slow or negative growth is already impacting profit forecasts across industries and could place further pressure on valuations. What should long-term investors be watching to focus on the big picture? Answer: The labor market and its impact on Fed policy.
Labor markets are pivotal to the Fed’s reaction function. The first jobs report of the year set the stage for this debate by showing that a healthy 223,000 jobs were added in December, bringing the unemployment rate down to only 3.5%, tying the lowest level since the 1960s. With December’s final number in, the economy added 4.5 million new jobs in 2022. While this doesn’t compare to the 6.7 million jobs created in 2021 as the economy bounced back from the pandemic, it is far above the 2.3 million and 2 million jobs added in 2018 and 2019, respectively. While a strong labor market appears healthy for the US economy, it presents a problem for the Fed as a tight labor market has historically contributed to higher inflation.
1 Breaking Down the Strong Labor Market
The most impactful data point within the labor market is the pace at which wages rise due to the tight link between wages and inflation. While higher pay for workers is undoubtedly good news for households and individuals, markets often view this differently. To Wall Street, wages that rise too quickly can spark “too much” consumer spending and spur inflation. Case in point: the surge in consumer demand fueled by excessive pandemic-related stimulus drove shortages and supply chain disruptions resulting in decades-high inflation.
Further, since wages represent costs to employers, upward pressure on pay results in inflation for businesses and corporations. As workers get paid more, companies feel the pinch to profit margins. As a result, businesses feel incentivized to raise prices to protect their margins, which pushes inflation higher and, in turn, motivates workers to ask for even higher wages. Economists call this dynamic a wage-price spiral, which is difficult to reverse.
But, harking back to the December job report, investors took the fact that wage gains slowed in December as a positive sign. Wage growth decelerated to 4.6% for the private sector and 5.0% for production and non-supervisory workers (i.e., typically hourly workers). This deceleration was better than economists had expected and represented a healthy deceleration from the 5.6% private sector peak last March. Slowing wage growth is consistent with other decreases in inflation over the previous few months, from energy prices to shelter costs.
As further evidence that wage growth may be slowing, the Employment Cost Index compiled by the Bureau of Labor Statistics suggests that salaries and wages decelerated from 5.7% last June to 5.2% in September. The Atlanta Fed Wage Tracker has also declined from a peak of 6.7% in July and August to 6.4% in November. While these moves may not be large, they are all in the right direction.
Investors, encouraged by the recent wage data, pushed markets higher since lower wage pressures corresponds to slowing inflation and, thus, a slowing of Fed rate hikes. While positive, it’s essential that investors do not get ahead of themselves. After all, hope that the Fed will begin to back off its aggressive policies drove numerous market swings last year. But hope is not a sound investment approach, and these rallies ultimately disappointed investors as the Fed reiterated its commitment to keeping rates higher for longer.
Considering the various dynamics affecting the market, economists forecast that growth could be flat for the year, with GDP slightly negative in the second quarter and positive again in the fourth. These projections are very sensitive to the Fed, inflation, and interest rates. Suppose inflation improves faster than expected, and the Fed is convinced to pause sooner or at a lower rate. In that case, markets and the economy might surprise to the upside. But, until that happens, investors should follow the long-term trends in the data and resist getting caught up in month-to-month moves.
2 So, what does Atticus’ Investment Committee expect for 2023?
The Fed’s new standard of waiting for “substantially more evidence” of inflation moderating implies that the liquidity cycle downturn coupled with quantitative tightening that started in 2022 may extend deep into 2023. But, despite this, there may be a period of relative peace in the first half of 2023. Why do we believe this? Because Atticus’ Investment Committee does not see the Fed’s quantitative tightening program affecting liquidity materially from its current levels between now and the end of Q2 for two reasons. First, we expect an accelerated drain from the Treasury General Account. Second, we expect a drain from the Fed’s Reverse Repo Facility due to increased T-Bill issuance as a cash management technique ahead of the debt ceiling showdown this Summer. All of which should work to stabilize markets, for now.
But that doesn’t mean investors are out of the woods quite yet. The Fed’s incorporation of the tight labor market into its reaction function will likely cause the Fed to over tighten into 2023 with no rate cuts or liquidity provisions until 2024. Given this dynamic, investors should remain cautious and well-diversified with attractive fixed income to offset any economic weakness created by Fed policy. Our Investment Committee believes in continuing to overweight defensive equities and maintaining a degree of cash as the probability of a Fed-created recession rises in the back half of 2023.