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Some Things Just Take Time
This week we received the latest monthly payrolls data. US employers added 209K jobs – a little lower than expected. However, the job market appears robust. One metric that deserves closer inspection are weekly hours worked. That is trending lower and could be a precursor to what’s ahead. From my perspective, what we’re seeing is the “Fed lag” effect of higher rates slowly tighten its vice. But these things take time and we may not see the full effects on the labor market for another 6-12 months (at a guess).
Fed Minutes Suggest More Hikes
Today the Fed released this statement from their latest minutes “The economy was facing headwinds from tighter credit conditions, including higher interest rates, for households and businesses, which would likely weigh on economic activity, hiring, and inflation, although the extent of these effect remained uncertain”. But here’s the thing: the market could be underestimating how long the lag effect is. Typically it’s between 12 and 24 months. However, with an extra $2+ Trillion in (perhaps wasteful) government handouts, that has softened the blow dealt from higher rates. But make no mistake – the lag effects from 500 bps of tightening will come – it’s just longer than expected.
‘Higher for Longer’ after May Core PCE
May’s print for Core PCE came in 4.6% YoY – still well above the Fed’s objective of 2.0%. However, mainstream were quick to label the report as ‘lackluster’. Why? Here’s the thing – Core PCE has hardly changed the past few months. It dipped in May to 4.62%, from April (4.68%), but was above March (4.61%), and was exactly where it had been in December (4.62%). Put another way – we have made no ground since December – and yet it was now somehow ‘lackluster’. But it gets better: core services inflation (without energy services) rose by 5.4% in May YoY. It was fractionally lower than April (5.5%) – but equal to what we see in both March and December (5.4%). Similar to Core PCE – it too is stuck in a tight range for 5 consecutive months. What does all this mean? Simple: rates will be higher for longer and markets don’t get it.
Stocks Are Not Cheap
The S&P 500 has had a fantastic first 6 months of the year – up almost 15%. That’s a welcomed relief from the miserable 2022. But are stocks now too expensive? What’s the premium investors are being asked to pay? There are a couple of ways we can assess this. For example, we can compare the earnings yield against the risk free rate of return (currently around 5.5% and going up). And whilst it’s always good to maintain some (long) exposure to the market – we need think carefully about how much (and where)