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NYSE trader is shocked! (Photo by Drew Angerer/Getty Images)
Wall Street’s logic is frightful – or laughable. Here’s the line of reasoning that caused the stock market to fall on Friday (10/8):
- The latest BLS Employment Situation report (focusing on the All Employees/Total Nonfarm data) showed slowing growth for September, but it was still “too good”
- Confirming the over-goodness was the lower unemployment rate
- Therefore, the Federal Reserve will not “pivot,” meaning throw in the towel, and now will feel free to raise interest rates further
- Following, those higher interest rates will inevitably cause a recession
- And that recession will produce lower employment growth and higher unemployment
The humorous side of all that is not just the circular reasoning. It’s the first line. “Too good” results from saying growth was above Wall Street expectations. Except the Street’s guesses are scattered. According to Econoday, they ranged from 220 to 350 thousand. Interestingly, that put the reported number of 288 thousand right into the middle of the range, equally better and worse than expected – or right on.
Moreover, the important part of the report is that the 288 is below August’s 315 increase – hence, a slowing rate of increase. In fact, that slowing is now a self-evident trend, visible in the following graph.
Monthly change in employees – seasonally adjusted
John Tobey (FRB of St Louis – FRED)
One more point to note: Seasonal adjustment
The actual amount of employment change varies month-to-month. Therefore, the BLS applies seasonal adjustments to create a “seasonally-adjusted” number that can be compared with other months. (Those are the figures in the graph above.) The following graph adds in the actual counts to show the wide dispersion of actual employment changes. Note especially the September to November holiday buildup, followed by the large post-holiday reduction in January.
Monthly change in employees – SA and NSA
John Tobey (FRB of St Louis – FRED)
Importantly, the seasonal adjustment numbers are not perfect. They don’t account fully for monthly variations, so seasonally-adjusted numbers should always be viewed as approximations.
A good use for the actual numbers is to compare the same months for a year-to-year change. For September, last year’s actual increase was 704 thousand vs this year’s 431 thousand.
One final point: Employment changes are puny
Hundreds of thousands certainly look impressive. However, the total number of employed in September was 153 million. That means the 431 thousand increase was only a 0.28% change. Using pandemic statistics, there were 280 new employees for every 100,000 existing employees.
So, all of that is the backdrop to the better logic…
First off, the latest employment report isn’t a scary surprise. Instead, it continues the slowing growth rate. A slower rate is healthy because it is helping correct the unhealthy mismatch of job openings to possible employees that was sparking wage inflation – just what the Fed is attempting to tame.
Similarly, the hot housing market is settling down as mortgage rates rise to “normal” levels. A 6+% mortgage is neither drastic nor a deal killer. It’s a fair rate in today’s financial market. It and higher rates have supported years of healthy and even boom housing markets. The main reason for the voiced concern is the speed of the rise. But remember – those recent, ultra-low mortgage rates were unsupportable in even a 2% inflationary environment, much less in the current one.
Likewise, with short-term business loan rates rising, last year’s strategy of increasing inventories to protect from shortages and higher costs is reversing. Companies are now focusing on getting inventory-to-sales ratios back to a reasonable level.
In other words, the rising rates are accomplishing the inflation reduction goal – and more. They are returning interest rates to normality – to the level established by the capital markets, operating continually – not by the dozen economists on the Federal Reserve Open Market Committee meeting occasionally.
Wall Street’s greatest bugaboo
When interest rates were abnormally low, Wall Street was in the catbird seat – filling investors’ income needs with stuff. Risk? Whatever. What’s the yield and potential gain?
Four good examples are…
- Special Purpose Acquisition Companies (SPACs) – Get your money back with interest or get into an expert-driven acquisition. (Small print legalese described the watering down by ~20% “free” stock given to insiders)
- Established but over-leveraged company IPOs coming out of private ownership (e.g., Weber and Dole)
- Exciting story biotech IPOs with large, negative cash flows (many tanked)
- Leveraged “products” that hyped returns (up and down) through borrowing
The bottom line – Wall Street wants what it can’t get: Yesterday
Yesterday’s gone, but the messes are not. That’s why it’s important not to look for “dead cat bounces.” The strategy of using low-cost debt to produce desirable results is, itself, dead. That tactic can be found in many places besides Wall Street. Even shoulda-known-better operating companies and pension funds got enticed into the easy gain through debt math.
As a result, index fund returns could be weakened because the passive, buy-all approach. Therefore, a better strategy likely will be investing in actively managed funds – ones where the fund managers and analysts are established experts. They will be focused solely on the future, not on reimagining the good ol’ days.