By: Stash Graham
The stock market continued its move higher in the face of slowing inflation and a labor market that continues to show strength. The market seesawed the last two weeks after a solid start to the month. The lead-up to the monthly options expiration date (June 16th) generated much early buying interest. The derivatives market had a short (bearish) bias coming into June. Those investors who were short the market needed to cover their positions by buying back stock before the option expiration date (OpEx). For the month, the S&P 500 returned 3.8%. The NASDAQ and Dow Jones Industrial Average gained 4.1% and 1.9%, respectively. Both bonds and gold posted slight losses as borrowing rates moved higher.
The primary story during June has been the contradiction between the deterioration of domestic leading economic indicators and the positive trending of coincident/lagging economic indicators. The central feature of the coincident economic indicator’s strength has been the labor market. We have highlighted, over the last few months growing signs of concern within the jobs market. While layoffs are increasing (4-week moving average) and job vacancies/postings are decreasing overall, the labor market remains tight. The primary factor for the tight labor market has been companies warehousing or hoarding workers. Companies are doing this hoping to avoid another two years (second half of 2020 to summer of 2022) where businesses struggled to find workers to fill the demand companies were receiving for their goods and services. The labor hoarding is confirmed by the material fall in labor productivity over the last couple of quarters. Maintaining workers that might not be needed is not a new idea, but it has been five decades since we last witnessed this level of severity.
Speaking of the labor market, we continue to be skeptical of the initial release reports detailing the job creation strength that we’ve seen so far in 2023. This skepticism is only exacerbated when you read statements from the private sector participants (i.e., ZipRecruiter CEO, as detailed in our April letter). As we have discussed at typical economic inflection points, labor market data is the most negatively revised economic data set. Typically the final revision comes a full year later after the initial release report comes out. The reason for suspicion that job creation is being overstated currently is because, over the last 12 months, the new business birth/death adjustment model has contributed over 1.5 million jobs to the non-farm payroll data. Important to note that contrary to its name, this model does not factor in job losses due to business deaths. This model only provides positive adjustments. As a result, over the last 12 months, the birth/death adjustment model has reported job gains of approximately 125,000 per month. This is important because non-farm payrolls have averaged 320,000 per month this year in 2023. In summation, almost 40% of the reported job gains that we have seen so far this year have been based on estimates of a model. When you consider the noted rise of bankruptcy filings and the significant increase in lending standards over the last year, it would be fair to assume that when these initial release reports get revised in eight-nine months that they will be revised lower because the models have underestimated the number of business deaths.
As a fiduciary, the continued challenge is to make prudent investment decisions on your behalf. We define a prudent investment decision by finding the best value a financial investment could offer for a person’s goals. Further, we observe value by comparing the risk and the reward of any investment. Currently, the S&P 500 is offering a forward earnings yield of approximately 5%. We find the forward earnings yield by taking the median average of 12-month forward-looking earnings estimates and comparing that to the market capitalization of the companies. As a result, if a person invested $100 in the S&P 500 over the next 12 months, they should expect that the $100 invested in the S&P 500 companies will generate $5 in earnings. In comparison, we could invest $100 in a two-year U.S. government agency bond yielding 5.5% and expect to generate $5.50 in annual “earnings.” Independent of “earnings” return, which skews in the government agency bonds’ favor anyways, we want to illustrate the material difference in risk between the two investments, as such the value of the short-dated U.S. government agency bond is much greater than the broad investment in the S&P 500. This does not mean that the S&P 500 will underperform the return of the government agency bond over the next 12 months; instead, we mean to illustrate the very high hurdle it takes to allocate new capital into the stock market.
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