Weekly Perspective: They Can’t All Be Zingers- Implications of Friday’s Jobs Report Miss

Well, no one was expecting that.

Leading up to Friday’s jobs data release the narrative was clear: the combination of a rapid vaccine roll-out and reopening of the economy was going to create a tidal wave of hiring as people returned to work. This notion was supported by improving jobless claims data through the month, strong employment signs from other surveys, and plenty of anecdotal evidence that business are now having a tough time finding workers to fill positions.

This led Street economists to expect 1 million jobs to be added in April.

So when the report was released on Friday morning showing a comparably paltry 266k jobs (seasonally adjusted) were added April, market participants were shocked.

This means that there are still 8.2 million fewer people employed today than prior to the pandemic.

Here are the takeaways from this dramatic miss to expectations. We also provide detail into the takeaways, plus charts below.

Don’t read too much into one month of data: this is always an important aphorism when looking at economic data, and is even more potent when comparing to extremely distorted data from 2020’s pandemic and shutdown influenced data. Recall that 20 million people lost their jobs in April of 2020, likely skewing seasonal adjustments. The 266k is a seasonally adjusted number, without seasonal adjustments, Nonfarm Payrolls increased by 1.1 million.
The slow pace of hiring likely has more to do with labor supply than labor demand: job openings and activity data point to an economic environment where businesses are looking to hire workers in order to keep up with recovering and strong demand for services and goods, respectively. And yet there appear to numerous possible drivers keeping workers from returning to jobs (high unemployment benefits, costs of private medical insurance, COVID fears, schools remaining closed, and skills mismatch).
This likely puts upward pressure on wages: wage growth surprised to the upside in April, while continued difficulty finding workers (possibly due to having to compete with higher government jobless benefits), could put upward pressure on wages and thus inflation readings.
This report likely justifies the Fed staying ultra-accommodative: this weak number likely gives the Fed evidential air-cover to remain ultra-easy with its policy, even as inflation expectations move higher through the summer months. This likely takes a discussion of tapering off the table at the Fed’s Jackson Hole meeting. Bad news carries higher weight than good news, so don’t expect the Fed’s tone to change if May or June payrolls reports show a big acceleration in hiring.
The Fed remaining easy will have implications on asset prices and behavior: a continuously easy Fed removes a negative catalyst from equity markets in the very near term because ultra-easy policy allows equity multiples to remain elevated and keeps volatility suppressed. A very easy Fed also puts downward pressure on the US Dollar (because other central banks are moving to tighten policy). A weaker dollar supports higher commodity prices (even gold, as seen by gold’s strong performance on Friday). A weaker dollar and higher commodity prices push longer term inflation expectations higher, which pushes long term nominal interest rates higher. Short term interest rates remain low, which means the yield curve can remain steep. Higher commodity prices, a weaker dollar, and a steeper yield curve all support improved performance for Value stocks. The performance for Growth stocks will depend on real interest rates (nominal interest rates minus inflation), so if real interest rates move higher, expect renewed pressure on Growth stock valuation multiples, but if real interest rates remain depressed, Growth stock underperformance vs. Value may be less pronounced.

Below we dive into some of the details of the labor report and its possible drivers.

The Data Details

As mentioned above, the seasonally adjusted April Nonfarm Payroll came in a 266k vs. 1m consensus.

There were numerous peculiarities in the sector data: manufacturing employment actually fell 18k despite the numerous reports that manufacturing workers are very hard to find (this could be due to semiconductor shortages halting production of automobiles). Retail employment fell 15k, despite robust retail sales. Construction jobs didn’t grow despite a red hot housing market. Leisure and Hospitality did add 331k jobs, but this number is seen as light given the rapid pace of reopening.

The Unemployment rate rose to 6.1% from 6% the month earlier. This increase was driven by workers re-entering the labor force, with the labor force participation rising to 61.7% (vs. 61.5% prior), which is a positive.

Another positive was the upside surprise to average hourly earnings, which grew +0.07% month-over-month (vs. consensus for +0.0% m/m). This increase to wages came even as hiring in lower wage areas of the economy rebounded.

Further, the average work week is getting extended across sectors, which implies further upside to job gains and wages. When existing workers have to work more you either have to hire more workers or pay more in overtime.

More About Supply Than Demand

This big miss in the jobs report has sparked a feverish debate as to why hiring was so slow despite perceived economic strength (see FT article here, see Bloomberg article here, see WSJ article here). Before getting into the reasons, we again note the distortions in this one month of data, which likely means that the underlying pace of job additions in the U.S. economy is likely higher than the 266k reported.

This FT article includes an interesting assessment that the U.S. labor market recovery has lagged behind other developed markets by a significant degree (see Chart 2 from Deutsche Bank featured in that article).

Most of the rationales for the miss argue that this has more to do with supply of labor (how many people are ready, willing, and able to work) vs. the demand for labor (how many workers businesses need). This is notion is supported by anecdotal and early data evidence that shows workers are hard to find, despite plenty of available jobs.

This WSJ article captures this dynamic with a couple interesting charts (see Chart 2 and Chart 3). We have also discussed this dynamic in our report on catalysts, which included a look at the Beveridge Curve (see Chart 4). This curve shows that unemployment is particularly high despite the level of job openings, which implies that workers are not taking available jobs. Another way to see this is the NFIB Job Openings Hard to Fill survey, which has surpassed the 2019 peak when the unemployment rate was only 3.5% (see Chart 5).

The arguments for why the supply of workers is constrained include:

High Unemployment Benefits: currently, the $300/week of supplement unemployment benefits nearly doubles the average $318/week benefit, meaning that those that are able to qualify for unemployment benefits can receive more than working full-time at $15/hour.
- This has led to a fierce policy divide about continuing these supplemental benefits through September as scheduled
- Some states (South Carolina and Montana) have now announced that they will end all pandemic related unemployment benefits for residents
- How accurate is the assertion that this is the main cause of slow hiring? We don’t have enough data to fully make that assessment, but comparing the hiring rate of states that continue to pay supplemental benefits vs. those that stop them will provide a real-time experiment. Further, we are seeing the combination of tight conditions, extended work hours, yet little hiring in higher wage areas (like business services) that make closer to $30/hour on average, implying that it is not just about unemployment insurance.
Cost of health insurance: there is another observation that staying on Medicaid is more attractive versus private insurance once hired because of rising premiums and co-pays with private insurance.
COVID Fears: this WSJ article includes a U.S. census survey estimate that 4.2 million people (of the 8.4 million fewer people employed compared to before the pandemic) are not returning to work out of fear to contracting or spreading COVID. Workers, mainly in service areas, may be reluctant to spend long hours in masks, while others are resistant to taking the vaccine (NYT article about vaccination rates slowing).
Schools remaining closed for in-person learning: less than 50% of school districts are back to full-time in-person schooling. This is putting a burden on parents to stay home and possibly not re-enter the labor force given lack of childcare options. This overhang likely cannot be resolved until after this summer, when children return to schools in the fall.
Mismatch of skills: much of the job loss than occurred in 2020 was concentrated in service sectors like hotels, restaurants, travel, etc. Now, much of the tightness in the labor market is in areas of manufacturing and other skilled areas. This implies that workers returning to the labor force may not have the skills needed by potential employers. Retraining workers takes time.
Party Like it’s 1999? Davey Day-Trader is Back: there is increased anecdotal evidence and supposition that some people are choosing to remain home and day trade stocks and crypto instead of returning to traditional work.

Chart 1: The U.S. is Lagging Behind Other Developed Countries in the Employment Recovery

^{Source: Deutsche Bank, via The Financial Times}

Chart 2: Job Openings Have Grown Substantially vs. Pre-Pandemic Levels in Numerous Industries That Have Benefited From Pandemic Trends, While Hard-Hit Areas are Recovering

^{Source: Wall Street Journal}

Chart 3: Job Openings Are Growing Much Faster Than Job Applications Indicating that People are Resistant to or Prevented from Returning to Work

^{Source: Wall Street Journal}

Chart 4: The Beveridge Curve Shows a High Level of Job Openings Despite Unemployment Remaining Elevated

^{Source: U.S. Bureau of Labor Statistics}

Chart 5: NFIB Survey of Job Openings Hard to Fill Indicates Businesses Having Trouble Finding Workers, Despite High Unemployment

^{Source: U.S. Bureau of Labor Statistics}

Last Week in Markets and Data

Equities Divergence

Major U.S. indices were mixed last week with the S&P 500 (+1.23%) and Dow Jones Industrial Average (+2.67% ) advancing, while the tech-heavy/long-duration NASDAQ (-1.51%) declined. This divergence was also seen in equity styles with Value advancing (+2.74%) and Growth declining (-1.03%). Sector performance was also dispersed with cyclical and Value oriented Energy, Materials, and Industrials the big winners, while Technology and Consumer Discretionary lagged (see Table 2 at the end of the note for sector detail).

This Bloomberg article makes the observation that equity markets have remained ebullient despite the macro or headline dynamics (inflation, deflation, reflation). This is due to areas of the market that benefit from each potential headline have been staging powerful enough rallies to make up for losses in out-of-favor names. This is partially a function of very strong inflows into equities YTD, despite valuations being at historically elevated levels.

Earnings Update

As of last week, 88% of S&P 500 names have reported 1Q21 earnings. 86% have beaten Street expectations (compared to a 74% 5-year average). The degree of earnings surprise is notable, with an aggregate 22.1% beat (compared to a 6.8% 5-year average). Aggregate 1Q21 earnings are now running up +49.4% YoY, which is significantly higher than the +23.8% growth expected when the quarter ended in March. Despite the big earnings surprises, the average reaction to earnings on the day of release has been -0.12% for S&P 500 names, this reflects that investors’ expectations were likely higher than sell-side Street estimates, and that valuations were already quite full and pricing in upside.

Spooked and Confused: Yellen Comments

Markets were briefly spooked and confused by Treasury Secretary Yellen’s comments that interest rates may need to move higher in order to avoid overheating of the economy given higher spending levels (see FT article here). This sparked a big sell-off in long duration, interest rate sensitive stocks (like technology and NASDAQ), but it interestingly did not cause a move higher in interest rates. Yellen subsequently had to walk back her comments, saying she was not intending to say that the Fed should be raising interest rates. But at this Bloomberg opinion article points out, Yellen’s initial comments could be a correct assessment, with the prospect for much higher Fed funds rates in the future (arguably quite far out) given expectations for higher growth and inflation.

Warned: Fed Financial Stability Report

The Fed released its financial stability report last week, warning of shocks to asset prices due to high valuations and excessive risk taking. In a statement accompanying the report, Lael Brainard said: “Vulnerabilities associated with elevated risk appetite are rising…The combination of stretched valuations with very high levels of corporate indebtedness bear watching because of the potential to amplify the effects of a re-pricing event.” We discuss this dynamic at length in our 2021 Outlook and Leverage paper. This Bloomberg article outlines the other topics discussed in the report.

Yields Drop Throughout the Week

The yield on the 10 Year Treasury bond fell -5 bps to 1.58% through the week. The yield touched as low as 1.46% on Friday following the jobs report miss, but bounced off of these lows to finish +1 bps for the day (see Chart 6). Inflation expectations climbed +7 bps on the week to 2.32%, meaning the decline in the nominal yield came from real yields falling. Note the decline in real yields was not enough to spark a rally in the long-duration names like Technology, NASDAQ, innovation, etc.

The 10-2 Treasury curve flattened 3 bps during the week to 142 bps. Interestingly, banks still rallied +4% on the week, despite the flatter yield curve. Banks’ performance and the yield curve are often correlated because the yield curve impacts bank profitability through the net interest margin, which is the profit banks make by borrowing at the short term rate (2 year rate is the proxy) and lend at the longer term rate (10 year rate is the proxy).

Dollar

The DXY Dollar index fell -1.15% to $90.23 during the week, erasing the majority of the YTD gains (only +0.33% YTD now). The Dollar has been coming under pressure for numerous reasons, including expectations that the Fed will remain much more dovish than other developed and emerging country central banks. This means the Fed will keep monetary policy much more accommodative/easy (with both interest rates near zero and asset purchases at pandemic crisis levels) than other central banks. Notably both Canada and the UK’s central banks have already announced tapering plans, along with a handful of emerging economies, while other central banks with rapidly strengthening economies are expected to remove aggressive accommodation soon (see Bloomberg article here).

As we discussed with Steve Ricchiuto last week in our podcast, the direction of the Dollar will be critical for the movement of many other macro indicators including inflation (a weaker dollar will likely push inflation higher because a weaker dollar will make commodity prices and import prices move higher), equity market rotations (a weaker dollar is likely supportive of the Value/Cyclical trade), and Fed policy (if inflation does move higher on a weaker dollar, this could get the Fed to begin removing accommodation).

The Dollar rally from earlier this year has reversed, while the currency remains near critical support (see Chart 7 and Chart 8).

Copper Hits a New All-Time High

Copper continued its feverish rally, rising +6.4% to $10,417. This is a new all-time high, surpassing the 2011 commodity supercycle peak (see Chart 9). This Bloomberg article does a good job at explaining the importance of copper in global manufacturing and construction, which is why it is used as a proxy for global growth. Copper has more than doubled in the past year on the back of increased demand for manufactured goods (housing, appliances, vehicles, etc.), increased government spending on infrastructure (mainly China, which is slowing down), strategic reserve restocking (mainly China), supply disruptions (mines have been closed in key producing areas like Chile due to COVID infections), transportation bottlenecks (higher transportation costs directly feed into commodity prices), expectations that demand will increase in the future due to the adoption of green/electrified technologies, and that supply will not be able to keep up to this step-change higher in demand.

Oil Moves Higher and Cyber Attacks

Oil prices rallied last week. WTI rose +2% to $64.90, bringing the YTD rally to +34%. Brent rose +1.5% to $68.28, bringing the YTD rally to +32%.
Over the weekend, a ransomware cyber-attack shut down the biggest U.S. gasoline pipeline (see Bloomberg article here). It has remained closed for three days and could threaten gasoline supply in the northeast of the U.S. If you are interested in learning more about the vulnerability of infrastructure to cyber-attacks, we highly recommend the book Sandworm by Andy Greenberg as a deep dive into the topic.

Manufacturing PMI Declines and Misses Expectations

The ISM U.S. Manufacturing Purchasing Managers Index (PMI) came in at 60.7 for April. This was below expectations of 65. Though still in expansionary territory, it was a decline from March’s 64.7. As we noted in our update on PMIs from last month, declining PMIs, even though still in expansion, are associated with lower equity market returns and falling valuations, as the market anticipates further moderation in the pace of growth. At 60.7, this level of PMIs is associated with the low forward returns for the equity market.