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Positive Labor Market

Mark DiOrio, CFA

US equities declined this week as interest rates rose rapidly. The non farm payrolls report was the major economic news of the week. The unemployment rate dropped from 3.8% to 3.6%, well within the Federal Reserve’s traditional thoughts on full employment. While the full employment number is not a pinpoint number, the Federal Reserve tries to assess the economy and support the economy to work towards full employment. Not only did the unemployment rate drop, but the labor force participation rate bumped up from 62.3% to 62.4%, representing an increase of 418,000 workers. The increase in wages showed annual wage inflation has hit 5.6%, the best numbers of the recovery for workers. In brief, the labor market is tight which means the Federal Reserve can focus more on targeting inflation (i.e. raising interest rates). However, the positive labor market also should provide a strong offset to economic challenges.

The economy grew at an annualized rate of 6.9% during the fourth quarter of 2021. There was strong consumer spending despite consumers feeling the burden of higher inflation. Profits were also very strong during the fourth quarter of 2021 earnings seasons, now fully reported. Nearly ¾ of companies beat earnings expectations.The earnings picture continues to be much stronger and more resilient than most market pundits have expected.

Inflation numbers have not slowed and have reached a recovery peak at 7.87%. Inflationary pressures are the primary concern for the Federal Reserve today. The uncertainty over geopolitical events have created a more challenges environment for setting monetary policy.

Chart of the Week

Market Update

Equities

Broad market equity indices finished broadly lower on the week with small cap stocks, and growth stocks leading the decline.Small cap and growth stocks are typically sensitive to rising interest rates.

S&P sectors varied wildly this week. A similar theme with energy having a strong week joined this week by health care and consumer staples. These are defensive types of stocks reflecting investors desire to shift portfolios more defensive. Energy holds a clear lead YTD, but zooming out to an investor’s time horizon, energy is also the worst performing sector over the last 5 and 10 years.

Last week ending 4/8/2022

YTD through 4/8/2022

Commodities

Oil dropped sharply on the week, closing below $100/barrel at $98.26/barrell. A combination of factors oil lower. First, China is imposing additional COVID-19 related lockdowns which should lower demand. Second, concerns that rising interest rates will slow down the US economy will lead to lower demand. Third, the US government released some oil from the Strategic Petroleum Reserve to alleviate supply concerns from Russia/Ukraine war.

Gold rose this week even as the U.S. dollar strengthened. Gold is a common “safe haven” asset, typically rising during times of market stress. Focus for gold has shifted again to include not just global macroeconomics surrounding COVID-19 damage and recovery efforts, but also inflation. A new source of volatility will likely continue to be the conflict in Ukraine, as conflict may push investors into safe havens.

Bonds

Yields on 10-year Treasuries rose this week from 2.47% to 2.72%, while traditional bond indices fell sharply. Expected increases in future inflation risk have helped elevate yields since pandemic era lows in rates. Treasury yields will continue to be a focus as analysts watch for signs of changing market conditions.

There are a number of challenges for traditional fixed income assets, but much of it may be nearly priced into the market. The bond market has moved extremely fast in anticipated future Federal Reserve interest rate moves.

Lesson to be Learned

One of the principal functions of the right financial advisor is to make sure the investor understands the volatility of his or her specific portfolio and is willing to stick with it for the long run. The process of rebalancing – which sells when the market is up and buys when the market is down – is sometimes referred to as “volatility capture” and leads to what Fernholz and Shay (1979) refer to as “excess growth”. The rebalanced portfolio will grow faster than the average growth of its individual constituents. It may even grow faster than any one of its constituents due to the rebalancing process. Thus, if handled knowledgeably, market volatility can be the investor’s friend.

– Harry Markowitz, PH.D, 1990 Nobel Prize Recipient

Legacy Indicators

Two simple indicators we share that help you see how the economy is doing (we call this the Recession Probability Index, or RPI), as well as if the US Stock Market is strong (bull) or weak (bear).

In a nutshell, we want the RPI to be low on a scale of 1 to 100.  For the US Equity Bull/Bear indicator, we want it to read at least 66.67% bullish. When those two things occur, our research shows market performance is typically stronger, with less volatility.

The Recession Probability Index (RPI) has a current reading of 31.05, forecasting a lower potential for an economic contraction (warning of recession risk). The Bull/Bear indicator is currently 33% bullish, meaning the indicator shows there is a slightly lower than average likelihood of stock market increases in the near term (within the next 18 months).

It can be easy to become distracted from our long-term goals and chase returns when markets are volatile and uncertain. It is because of the allure of these distractions that having a plan and remaining disciplined is mission critical for long term success. Focusing on the long-run can help minimize the negative impact emotions can have on your portfolio and increase your chances for success over time.

The Week Ahead

This week will see updates to the Consumer Price Index and related measures along with Producer Prices. The market will be watching these numbers closely.

More to come soon. Stay tuned.

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