Plausible Deniability

By Hightower Omaha on May 9, 2024

May 8, 2024

Two developments last week put a bid under a teetering stock market. Prior to these developments, the S&P 500 had sunk about 4.5% from its all-time high on March 28 of this year. The selling pressure reflected investors’ concerns that the Fed may have been premature in its plans to cut interest rates. The fears were reinforced by several inflation indicators that suggested the disinflationary trend may have reversed. Yet in just the past three trading days, the S&P 500 has recovered about 70% of the aforementioned decline. What happened? Has the inflation threat dissipated yet again?

The first event that brought stock buyers back into the market was the press conference following the Federal Reserve’s May 1 meeting. During the Q&A session, Chairman Powell conveyed his belief that the recent inflation data had not necessarily changed his expectation for a return to 2% inflation. In doing so, Powell effectively dispelled the notion that the recent uptick in inflation could actually lead to rate hikes instead of rate cuts. A more likely scenario, Powell suggested, was that the recent inflation data simply reflected a blip in a downward inflation trend that was never expected to occur in a straight line. Once investors heard that reassurance, they started buying.

But the more potent catalyst for stock bulls was Friday’s labor report. We learned from that report that the economy added just 175,000 jobs in April, significantly below the consensus estimate and the fewest since October of last year. We also learned that the unemployment rate ticked up to 3.9%, which was above the expectation of 3.8% and the highest since January 2022. And finally, average hourly earnings grew just 3.9% year-over-year in April, which was the lowest growth rate since May 2021. Each of these data points falls under the category of “bad news is good news” because a weaker labor market means slower wage growth, and slower wage growth means lower inflation. Taken together with Chairman Powell’s commentary last Wednesday, investors have set aside their inflation worries for now.    

There are other instructive data points buried within the various labor market indicators. The first thing to point out is that, though in fits and starts, the labor force continues to grow. Immigrants and people coming off the sidelines continue to supplement the supply of labor, which should keep wage inflation in check if it continues. 

Second, the number of job openings, which is an indicator of labor demand, has declined from a high of 12.2 million in March 2022 to 8.5 million in March. The decrease in openings has taken the ratio of job openings to the number of those officially considered “unemployed” from over 2.0x to the current 1.3x. The supply of and demand for labor are becoming much more balanced. 

The next couple of metrics offer insight into the labor force’s confidence and psyche. A plummeting quits rate suggests that prospective job switchers have less incentive to switch jobs. One reason for that could be that the opportunities for greater compensation through a job change have diminished. 

The “Labor Differential” is a metric that tracks the difference between those who believe jobs are plentiful and those who believe that they are hard to get. The chart below shows that optimism has dropped precipitously over the past three years – another signal of a cooling labor market. 

One final data set is a little more ambiguous. Though year-over-year gains in pay for people who stay in their current jobs continue to fall (to 5.0% in April from 5.1% in March), pay growth for job changers remained elevated at 9.3%. If there is a silver lining to that number, it is that the 9.3% gain in April was down from 10.1% in March. Also, recent pay gains for job changers are well down from the mid-teens increases from late 2021 to early 2023. 

All stock investors want out of the Fed right now is plausible deniability that the disinflationary trend has not been broken. Recent labor market trends provide that plausible deniability. Demand for and supply of labor are becoming much more balanced, which puts a cap on the rapid wage gains that typically lead to outsized consumer spending, particularly on services. So until we get the next data point suggesting otherwise, investors are more than willing to believe Chairman Powell when he says he’s not worried. In my opinion, this heavy dependence on the next data point is not the best time to be backing up the truck on stocks. But then again, I’ve thought for some time that inflation is yesterday’s problem. 

Peace,

Michael