By Jeff Weniger, CFA
Head of equity strategy
It’s good when the unemployment rate is low, right? Of course it is. The problem is that extremely low unemployment often comes at the end of the good times, not the beginning.
It’s a bit counter-intuitive. Intuition would say that abundant employment should probably be good for the return on capital. The problem is that unemployment rates below 4% often indicate an overheated economy. Even a half point back up from these extreme lows is often enough to identify a recession. We only have a sample of four people, but that’s what happened in 1957, 1968, 2000, and 2020 (Figure 1).
Figure 1: If the unemployment rate increases by half a point from below 4%, the probability of a recession increases
The last three unemployment reports were at 3.6%, and as far as I know, maybe the next ones will be even lower.
But what if they don’t?
After all, I can’t just condone a series of outright hiring freezes or layoffs that were recently announced at Tesla, Salesforce, Uber, Snap, Meta, Facebook parent, Instacart, Coinbase, Gemini and Microsoft, among others. To be fair, the hiring plans of Fidelity, Ford, Subway and JP Morgan indicate that there are also large companies actively hiring at the moment.
The summer kicked off with the long-awaited Job Openings and Labor Turnover Survey (JOLTS), which reported – again – more than 11 million job openings in the United States. Subtract the number of unemployed, and the result is extraordinary (Figure 2). However, take out a microscope and note that it may have peaked this spring. Inflection points matter.
Figure 2: US job openings minus the number of unemployed
The 390,000 jobs created in May represented a solid report, a sigh of relief for a country struggling with stubbornly high gas prices and $7 Cheerios. Many on the street, myself included, were preparing for a disappointment that did not materialize.
There are a few positive omens that might give the system a bit of a boost.
On the one hand, China has finally let millions of people out of their apartments. For closed factories, that means activity went from zero to normal with the flick of a switch. Not a moment too soon for the disaster that lingers in the global supply chain.
OPEC had also been increasing oil supply by an additional 400,000 barrels per day with each passing month, but the cartel recently announced it would increase that figure to an additional 650,000 barrels per day. It’s much needed considering the $6 to $7 per gallon drivers pay for gas in our most populous state, California. Where I am in Illinois, the dreaded “6-handle” has hit many gas stations.
But OPEC’s supply increase may be too low, too late.
In four of the last five serious drops in Michigan’s consumer confidence index, the economy was in or heading for a recession. This makes me think that the next unemployment stop is 4%, not 3%.
Figure 3: University of Michigan Consumer Confidence Index
Here’s another troubling metric: the National Federation of Independent Business (NFIB) survey question on sales prospects. The ranks of small businesses that anticipate a drop in sales over the next six months continue to grow.
Figure 4: NFIB sales
This calls into question whether an unemployment rate of 3.6% is a “good” thing for what we are trying to do, which is to make money in the stock market. Not if you think an unemployment rate below 4% means we’re on the edge of a precipice.
I think it’s safe to say that the market has been forecasting an economic slowdown and/or recession all year. Beneficiaries have been indices such as the S&P 500 High Dividend and the S&P 500 High Dividend Low Volatility, in stark contrast to the other side of the coin: the S&P 500 Pure Growth (Figure 5).
Figure 5: YTD return, S&P 500 factor indexes
I suspect these forces will remain key drivers, not least because I don’t think the street fully appreciates the risks that could arise in both housing and the labor market. Given that the market will have to spend this summer, and possibly beyond, digesting some unpleasant surprises on both fronts, it seems to me that a “stay the course” view makes the most sense.
This means low volatility and high dividend concepts instead of trying to be a hero in growth stocks.
Originally published by WisdomTree on June 21, 2022.
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