The US created another 151,000 jobs in August, according to Friday’s non-farm payrolls data. That disappointed markets initially, but is close enough to market expectations of 180,000 to continue a six-year trend of robust employment growth. The poor number for May of this year looks more and more like an outlier.
What do markets make of it? As of 9:30 Eastern Time on Friday, the dollar and the two-year US Treasury yield were down. The probability of a US rate hike at the September 21 meeting of the FOMC, as implied by Fed Funds futures prices, had gone from 24 per cent yesterday to 21 per cent, but there is still a 55 per cent chance of a hike by the end of the year.
This was an eagerly awaited jobs report. After Fed Chair Janet Yellen used her Jackson Hole appearance to say that the case for a hike “had strengthened in recent months”, and Vice-chair Stanley Fischer hinted strongly at a move in September now that the labour market “is very close to full employment”, the payrolls were freighted with extra significance with regard to the path of interest rates.
The Fed Funds rate is undeniably an important price in global markets. Expectations around it affect the yields on bonds and define the discount rates for corporate cash flows. But by putting so much emphasis on what today’s number means for September’s Fed meeting, are we in danger of missing the real story?
At the end of the day, jobs and wage growth don’t drive stock prices or credit spreads. Corporate earnings growth drives stock prices and corporate cash flow drives credit spreads.
If you went back through all of the 10-per-cent-plus corrections in the S&P 500 Index, what conditions would you expect to find? High valuations? They have certainly been a factor — the higher you are, the further there is to fall. But the relationship with low or negative year-over-year earnings growth is even stronger: It has been present for almost half of these corrections. Technicals matter, but fundamentals are, well, fundamental.
We have written a lot about the current earnings recession, which persisted into the second quarter of this year. Wherever you look, from S&P 500 data to the broader corporate profits section of the National Income and Product Accounts published by the Bureau of Economic Analysis, you see a profits recession akin to those during the financial crisis of 2008-09 or the aftermath of the tech bubble.
Markets have shrugged that off as largely symptomatic of problems confined to the energy sector, supported by aggressive interventions by global central banks and dovishness at the Fed. We believe they are right to have done so, based on our conviction that, at this stage in the cycle, earnings should recover as the oil price stabilises and the dollar plateaus. But at current valuations, signs of an earnings recovery over the next two quarters are really mission-critical.
Jobs data suggest corporate confidence
What might today’s jobs data tell us, then, a month or so ahead of the next earnings season? In itself, not very much. But, as part of a trend, and in combination with other recent data, it could be cause for optimism.
If companies had lost all confidence in their ability to grow earnings, the ongoing hiring spree would have to end. The fact that it shows no signs of doing so suggests that managers retain their confidence. Moreover, the men and women on Main Street feel that confidence, too: Survey data published by the Conference Board earlier this week showed consumer confidence smashing expectations with its highest reading for a year, and the “labour differential” indicated that a higher proportion of people think it is easier to find a job now than for almost a decade. If Fischer is right and we are close to full employment, it’s not because companies have a hiring freeze on.
To be frank, it probably would have taken more than one dire jobs number to sap the momentum for a rate hike sometime this year. Adding 151,000 jobs keeps that momentum in place. But for investors, the timing of the next rate hike is not the real information the jobs data contains. Just as important is what it says about confidence in the US economy, and the potential for that to be realised in corporate bottomlines over the next two quarters.
— Brad Tank is a Managing Director, Chief Investment Officer, and Global Head of Fixed Income at Neuberger Berman
