Noisy Number

This morning’s Employment report was weird, to say the least. The official unemployment rate dropped from 4.1% to 3.9%. That is awesome! The non-farm payroll was 199,000, compared to the consensus estimate of 422,000. Pretty disappointing! On the other hand, both October and November’s payroll numbers were revised upward by 142,000 new jobs! Great news! Yet, the labor participation rate barely budged at 61.9%. Finally, average hourly earnings jumped .6% vs. expectations of .4%. This is called wage inflation! What gives?

There is a great deal of noise in these numbers. For quite a while, I have been suspect of the antiquated methodology of government economic statistics. Historic analysis demonstrates that the government underestimates the drop in employment in contractions and the rise in employment in recovery. The October and November payroll revisions demonstrate this. I would guess that today’s 199,000 will be revised upward next month. Despite the noise, today’s number simply confirms that the labor markets are very tight. The unemployment rate is a remarkable 3.9% and wage inflation is likely to be an on-going problem for the Fed.

The market is concluding that the economy is on firm ground and has the potential to accelerate if Omicron cooperates. Inflation has become a bigger concern. It is amazing to think that just last September, the markets were forecasting zero interest rate hikes in 2022. The market is now calling for four interest rate hikes in 2022, with the starting point jumping to March. Expectations are the Fed will increase the pace of tapering and may even begin to shrink its balance sheet. This is a dramatic change! The Treasury market has responded rapidly to this new forecast. The ten-year Treasury note yield has popped from its year-end 1.52% to 1.77%, a significant technical level. That is a .25% increase in just the first five days of 2022!

On the equity side, the market is reacting to higher rates and predicting an imminent peak in Omicron. Higher interest rates have created a “Spec Wreck.” As noted in previous blogs, higher interest rates are kryptonite for highly speculative growth stocks. I have been the boy who cried wolf on these speculative stocks. Turns out that valuation does matter! Ouch! The Spec Wreck is dramatic and painful! There has been a meaningful shift from Tech and growth to cyclical and value. The leading sectors are now financials, energy, and materials. (It’s cool to be a banker again!...not really, it was never cool to be a banker!) This is the economic reopening trade. On a note of caution, we’ve been there, done that back in March and again in October only to be derailed by Delta and Omicron. For now, the market is anticipating a peak in Omicron, much higher interest rates and a more dramatic reopening. Today’s noisy employment report supports that thesis. Let’s hope it’s right!