March 13, 2023
February labor market data eased slightly from the hot January readings, but remained stronger than expected – and likely too strong for the Federal Reserve’s (“Fed”) comfort – confirming that January reflected ongoing momentum, not just seasonal abnormalities. Initial jobless claims did perk back above 200k this past week, but otherwise remain range-bound at low levels. JOLTs once again confirmed labor demand far exceeds available supply, and nonfarm payrolls increased a stronger than expected +311k in February, but were partially countered by a higher unemployment rate and more modest wage gains.
A temporary decline in mortgage rates in January provided the housing market a brief respite, leading to a pickup in existing home sales, stabilization in home prices and a modest rebound in builders’ sentiment. However, that was short-lived as rates rebounded back above 7%, causing mortgage applications to plunge once again. Auto sales are rebounding as production gradually improves, allowing pent-up demand to get filled, but this too is unlikely to last long. Consumer sentiment had been improving off 2022’s lows, especially as job and wage growth remained strong and inflationary pressures eased. However, as reflected by the Conference Board’s latest survey, confidence fell in February, and consumers still have a historically pessimistic future outlook for the economy. The Atlanta Fed GDPNow continues to project faster Q1 growth (+2.6% q/q A.R.) than the Blue Chip Consensus, which is beginning to close the gap with GDPNow. Lastly, the Cleveland Fed’s inflation NowCast points to the likelihood that inflation continues to track higher for February and March as goods deflation lessens and services inflation remains elevated and sticky.
Jay Powell seemingly put a +50 bps rate hike back on the table for the March FOMC meeting during his Congressional appearance last week, but the demise of Silicon Valley Bank (“SVB”) (and fears of contagion) quickly reduced that likelihood and instead opened the door to a “pause.” The fallout from SVB is still to be determined, but regulators were working feverishly over the weekend to limit the damage and calm fears. A key question now is whether the Fed abandons its inflation fight for the sake of financial stability.
Meanwhile, S&P 500 earnings estimates continue to be revised lower. To the extent that wage growth remains elevated and sticky while pricing power weakens, corporate profit margins remain at risk. As such, with equity valuations still full, earnings estimates still falling, investor sentiment still too hopeful, and now a banking crisis emerging at the same time the Fed is working to combat inflation, market risks are particularly elevated. The Fed must deftly navigate these treacherous waters without committing a policy mistake, a highly uncertain proposition to be sure. At a minimum, this situation would seem to argue for a higher equity risk premium, and thus lower P/E multiples.