While it lowers the probability of a near-term recession, it also implies a higher probability of additional Federal Reserve (Fed) interestrate hikes that could ultimately lead to a recession, albeit with a delay. Additional good news is that wage inflation, closely watched by the Fed, continues to moderate. While the January business surveys give a mixed message, they are also consistent with falling inflation. The market remains keenly focused on this battle between inflation and Fed rate hikes to combat it.
With about 70% of the S&P 500 Index reported, fourth-quarter earnings are tracking at an unspectacular 1% year/year decline, while earnings for 2023 continue to be revised down with growth of 1% now expected for all of 2023. Given the market’s forward price-to-earnings valuation ratio of about 18, this suggests limited upside potential for stocks in the near-term.
Resilient Labor Market
Nonfarm payrolls rose an impressive 517,000 in January—nearly triple expectations of 187,000. Similarly, the unemployment rate ticked down to 3.4% from 3.5%, the lowest since May 1969. Also impressive was the jump in the average workweek to 34.7 hours from 34.4, which is the equivalent of adding another 1.15 million to private payrolls. An important bright spot for financial markets was that average hourly earnings (AHE – a key metric the Fed is watching) rose “only” 0.3% with the y/y change slowing to 4.4% from 4.8%. This is down meaningfully from the peak rate of 5.9% last March.
Other important labor market indicators confirm the strength seen in the monthly payrolls report. The JOLTS report showed job openings rose by 5.5% in December to 11.0 million. This represents the largest monthly increase since July 2021, led by gains in accommodation and food services, retail trade, and construction. Job openings increased across firm sizes, led by small and mid-sized companies.
The JOLTS report also showed the layoff rate edged up to 1.0%, but still near its lowest level on record. The quit rate was unchanged at 2.7%. While off its peak level of 2.9% earlier in this cycle, the quit rate is still higher than the pre-pandemic level of 2.3%, as workers remain optimistic about their job prospects, which is another sign that labor market conditions are still strong.
The weekly jobless claims report is probably the most timely and accurate labor market indicator, and it continues to signal labor market tightness. Initial claims for unemployment insurance fell 3,000 last week to 183,000—the lowest level since last April. Claims have declined or held steady for five consecutive weeks now and are basically in line with the pre-pandemic level.
Mixed Signals from Business Surveys
The ISM Services PMI rebounded in January with the biggest increase since June 2020 and the second most on record, nearly reversing the drop at the end of 2023. It pushed the index back into expansion territory, consistent with continued growth in the broader economy. Ten services industries registered growth in January, while eight contracted. The net number of two was the lowest since May 2020, but positive and consistent with an ongoing expansion.
The New Orders Index surged the second most ever as demand rebounded. Export orders also recovered strongly, a sign that external demand improved as well. Importantly, the Services Prices Index dipped to its lowest level in two years. It shows that cost pressures in services, although still higher than pre-pandemic, continue to moderate.
In contrast to the positive services survey, the ISM Manufacturing PMI dropped in January to its lowest level since May 2020. Excluding the pandemic, this was the lowest PMI since June 2009. It has been below the break-even level of 50 for two consecutive months now, indicating a deepening contraction in manufacturing activity. Just as in the previous month, there were only two industries out of 18 that registered growth in January, the smallest share since April 2009, consistent with a decline in manufacturing output.