To Understand the Macro, Study the Micro

Shannon L. Saccocia, CFA, Chief Investment Officer—Private Wealth

Right now, second-quarter earnings reports may be a better guide to the economic outlook than official statistics.

Our major central banks are now avowedly “data-dependent.” And if we believe the latest from U.S. Federal Reserve (Fed) Chair Jerome Powell, speaking at the ECB Forum on Central Banking last week, labor market data are what they are now most dependent on.

We agree that where the labor market goes, there goes the economy. But looking one, two or three months into the past is unlikely to help investors prepare for the future. Empiricism might seem sensible when economic forces are so idiosyncratic and cycles are inflecting, but that is also when data tend to become noisy and subject to large revisions.

So, how should investors prepare?

At these cyclical inflection points, we believe top-down views need to be bottom-up informed; the macro should be micro. If there is weakness in the jobs data in three months’ time, it will likely be because companies started seeing weakness in demand three months ago and are cutting workforces today. In our view, that makes the second-quarter earnings season, kicking off this week, an important source of insight.

Choose Your Story, Select Your Data

To get a sense of how difficult forming a “data-dependent” view is, here’s a flavor of some recent jobs-market numbers.

Friday’s U.S. non-farm payrolls for June came in at 206,000, narrowly beating forecasts, though down from May’s numbers. But not only has this data from the Bureau of Labor Statistics been unusually volatile lately, its generally upbeat picture has been completely at odds with the same agency’s Household Survey, which showed unemployment ticking up—and no one seems entirely sure which is closer to the truth.

In addition, U.S. continuing jobless claims have been rising faster than forecast, to a 2.5-year high. Initial jobless claims marched higher through May and June, with the four-week average now as high as it has been for a year.

And yet the Job Openings and Labor Turnover Survey (JOLTS) suggests quite a tight market: openings and hiring rates unexpectedly rose in May and the quits rate also held up; one had to dig into the private-sector layoff rate, which ticked up by 0.1% to 1.2%, to find anything of even slight concern.

Purchasing Managers’ Index (PMI) surveys are proving equally mixed and confusing.

Last week, the S&P Global U.S. PMIs suggested that both manufacturing and services activity increased their rate of expansion in June, with services particularly strong and companies adding to staff. But somehow, the Institute for Supply Management (ISM) uncovered a totally different economy, where manufacturing fell further into contraction, services plunged alarmingly from expansion to contraction, and employment in both sectors declined.

Choose your macro outlook and select your dataset. Any story you want to tell has respectable-looking numbers to back it up.

The Clarity of the Micro Lens

If you want to do more than tell a convincing story, we think it is time to pay close attention to what company management says over the next eight weeks. Just as important, look past the usual chatter about whether earnings beat expectations. Instead, focus on what the key players in each sector are saying about their 12-month outlook for demand and staffing.

If the majority anticipate strengthening demand—which is not what we anticipate—it may be time to start worrying about a return to sticky inflation. More likely, in our view, are forecasts of a meaningful slowdown that will require “right-sizing” job cuts; or something more incremental that will enable firms to cut output while holding onto most of their staff—the widely anticipated “soft landing.”

In terms of immediate market sentiment, we think the messaging from the Software industry is likely to be the most consequential. Is activity around artificial intelligence (AI) about to dip? We don’t think so: the companies investing there are awash with cash. But could rising AI spending cannibalize demand for other software and technology? Certainly, and that will bear watching.

In Industrials, we think we may see an upbeat demand outlook as management adjusts capex plans to a more protectionist environment, in which near-shoring and reshoring becomes entrenched. Financials have already been cutting back staff; should rates decline and M&A activity pick up, they would be entering a favorable environment as leaner operations, and may even start rehiring.

Of greater concern to us are the Consumer-oriented sectors, which could report further deterioration, especially in demand for larger items that tend to be purchased on credit.

While the Tech sector might get the headlines, we think the balance of sentiment in the other industries will tell us more about the strength of the broader economy over the next 12 months.

We know our strengths at Neuberger Berman. With our big credit and equity research teams and our data science capabilities, we believe bottom-up insights can always inform an investor’s macro view. However, at this stage in the cycle, and following three extraordinary years in economic, financial market and monetary policy history, we think the micro lens may be the only one with any clarity.