Higher for longer, longer is OK

It’s been a good week! We are nearly halfway through earnings now, and so far it’s been solid, with 43% of companies growing over 10%, the highest since 2022. More than two-thirds of companies are beating on earnings and almost two-thirds have beat on revenues, with half of firms exceeding on both. These numbers are above average.  The S&P 500 gained 1.7% in January even as, on an equal-weighted basis, the stocks in the index dropped 0.7%. This as breadth narrowed, with just 34% of the S&P outperforming the index. Interestingly, this is consistent with the top-heavy strength of large-cap company earnings this season. While January has been fairly solid (at least on a cap-weighted basis), February is a historically worse month in election years. Fundstrat says the first level of concern would be if we breached 4,802, the S&P 500’s Jan. 12, 2024 low.

Booming job market. January had a terrific jobs report (more below). The new jobs were concentrated particularly in professional and business services (74K vs. the 2023 average of 14K!) and—due to the aging of the Boomers (you’re welcome)—in health care (70K), with particular gains in ambulatory care, hospitals and nursing homes. Average hourly earnings rose more than expected on both a monthly (0.6%) and yearly (4.6%) basis. Not only is a March cut out the window, but the Fed will likely be quite patient before making any move. In any event, Wolfe suggests the wage gains were mainly a function of early-year annual raises in salaries catching up to inflation. UBS concurs that it isn’t as inflationary as it might look, saying weather played a role. Strong wages can be OK if productivity saves the day. And, in this week’s news, productivity rose more than expected while unit labor costs rose less than feared (more below). Challenger, Gray and Christmas reported that layoff announcements rose in January to 82K. Still, this was lower than one year ago. And importantly, the January 2023 layoffs cited economic conditions where the latest announcements cite “restructuring,” indicating that these layoffs may not be cyclical.

In walks the Fed to ruin our week? The labor market along with shelter are the two stickiest components of inflation. With the vacancy rate near a record low (more below), housing costs are likely to remain stubbornly high. This week brought the Employment Cost Index, which rose 0.9% in the fourth quarter, a bit below consensus. Year-over-year, it’s still above 4%—the Fed cites a 3.5% wage growth figure with 1.5% productivity growth to meet its 2% inflation target. Not quite there yet. But while the market is pushing its expectations back, it still expects 5-6 cuts this year. So what? Deutsche looked back at fed fund futures and found that the market’s ability to forecast around turning points in rates is poor. So don’t count those half dozen cuts before they hatch. Core PCE inflation (the Fed’s preferred measure) is up 2.9% over the last 12 months but has slowed to a 1.9% annual rate over the past 6 months. Some in the press have said that this 1.9% rate could be a reason to declare victory now, but Powell repeatedly said that first he wants to see 12-month data come down further. Deutsche notes that historically the outcome of previous easing cycles once rate cuts begin is binary—either a big rally or else a recession eats heavily into any eventual gains. There’s no recession in sight! For its part, Wolfe looked back at the Fed during election years and found no pattern of the Fed putting its thumb on the scale. The government continues to pursue election-year fiscal stimulus, with the House passing a $78 billion tax relief bill. It’s unclear, though, whether that will pass the Senate. A fully employed economy with good earnings growth and inflation below 3% is what many call “immaculate deflation.” Surely the Fed will cut numerous times this year! Not if they really are waiting for 2.0% inflation. Indeed, when asked in his press conference when it would be time to cut, Powell explained that he just wants to be sure inflation doesn’t stabilize above the 2% target—in other words, higher for longer, longer. And that’s OK.

Positives

• Jobs boom The economy added 353,000 new jobs in January, well beyond the 185K expected, even as unemployment remained at a historically low 3.7%. Nonfarm productivity increased at a 3.2% annual rate in the fourth quarter, well above consensus estimates of 2.3%, while unit labor costs rose at a 0.5% rate vs. expectations of 1.1%. No doubt the average hourly year-over-year wage increase of 4.6% has been noticed by the Fed.
• Consumers feeling better The University of Michigan’s consumer sentiment survey rose in January to its highest level since July 2021, meeting expectations. The Conference Board’s consumer confidence survey rose by more than expected to its highest level since December 2021. All income groups saw an uptick in confidence except—“richcession” alert—for a dip in the $125K+ segment.
• They’re building as fast as they can Construction spending rose by 0.9% in December vs. an expected 0.5%. Also, November’s figure was revised higher from 0.4% to 0.9%. Spending on single-family homes rose 1.6%.

Negatives

• Rooting for a 6% mortgage rate In a sign that mortgage rates are taking a toll, home prices as measured by the S&P Case-Shiller index fell 0.2% in November from the preceding month (vs. an expected 0.5% increase), the first monthly decline since January 2023. Prices are up 5.1% year-over-year.
• Less worse Following other regional surveys, Chicago-area business activity as measured by the Chicago PMI decreased more than expected in January. Overall, U.S. manufacturing as measured by the ISM’s PMI survey contracted less than expected in January. Still, it was the fifteenth consecutive month of contraction.
• Transatlantic blues The EU narrowly avoided entering a technical recession, recording unchanged economic growth in the fourth quarter following a 0.1% drop in the third quarter. GDP in the EU has been below 0.5% since the end of 2022.  

What Else

If breadth is to advance, small companies have to join the party Small caps have been range bound lately, but there are constructive signs beneath the surface. Volume has surged on up days but has been muted on down days, a positive development. Financials and health care are big players in the small cap space, and they are improving.

The aging continent The EU’s unemployment rate is at 5.9%, down from 6.1% year-over-year and well below its long-term average. This may reflect labor hoarding due to high vacancy rates and shortages of skilled workers. The World Bank says the working age (15-64) population of the EU was declining by 700,000 a year last decade. It’s due to shrink at a rate of 1.5 million per year in the 2020s.

No wonder it “tastes just like chicken” Globally, human beings eat 74 billion chickens per year, roughly 9 birds each. Also, showing what comes first at least in this regard, we consume 1.2 trillion eggs annually, about 161 per person.