Will the Labor Market Take a Turn for the Worse?

On this episode of The Long View, senior markets commentator at CNBC, Michael Santoli, talks economic outlook, inflation, housing, and more.

Here are a few excerpts from Santoli’s conversation with Morningstar’s Christine Benz and Jeff Ptak:

Economic Weakness and the Equity Market

Christine Benz: Switching over to the economy. The stock market has been rangebound. I’m wondering, is there any reason to believe the market is beginning to sniff out economic weakness, the equity market?

Michael Santoli: Yes, it’s difficult. In pockets, arguably, yes, you’re able to say that. As has been constantly noted, it’s a very uneven market in terms of the performance this year. S&P 500 is obviously not exclusively but largely driven by the noncyclical mega-cap growth stocks. You’re up 16% on that group. And then, the equal-weighted S&P is up 4% this year. So, clearly, there’s a lot of differentiation happening.

I have been encouraged that things like homebuilders to a lesser degree and also industrials broadly speaking seems like what they’re pricing in is just capacity, scarcity, and the need for an investment cycle and capacity. Industrials are working there. But I do think that the market implicitly is mostly priced for continued somewhat benign economic conditions except in pockets of consumer cyclicals where I do think you’ve seen some wear and tear clearly on pure retail-type stocks but even hitting things like airlines. So, you have to squint, you have to decide what the message is. But at this point, I do think that the market is very indecisive about how late we are in the cycle or maybe how long we can stay late cycle. I think I recall that debate from 2018/2019 as well where you could say we’re late in the cycle because unemployment is so low and the Fed’s almost done tightening perhaps, but that doesn’t really tell you how much sand is left in the hourglass.

Positives and Negatives of Economic Fundamentals

Jeff Ptak: When you look at the economic fundamentals, what jumps out as the biggest positives and the biggest negatives at this point where we are?

Santoli: I think the biggest positives are perhaps the initial conditions from which the economy has had this maybe slowdown. The Fed has had to tighten. Meaning, consumer and corporate balance sheets just being much healthier. We talked about the supposed excess savings among consumers having been largely depleted. But the fact is, there was a lot of excess savings and you’ve actually been able to see that in the household aggregate leverage numbers. Obviously, it’s not equally applied. So, there’s some stress at the lower income side of things. But I would say that just in general the initial state of consumer and corporate balance sheets were a big positive. And this long stretch of time at very high nominal growth and high wage growth and low unemployment, it seems like it’s created a level of activity that’s not necessarily going to get depleted all at once. So, those would probably be the positives.

The negatives are: how much better can those things get? When you got to 3.5% unemployment, you might be bumping toward some kind of structural low in unemployment and there’s clearly been a reset of interest costs higher that is working its way through. So, I’m not of the opinion that, well, the Fed managed to hike 525 basis points, 10-year yields went from 50 basis points to 4.3 and we didn’t really feel it. I don’t think we really didn’t feel it. I think that it’s there, it just has some offsets that we’ve been enjoying for a while now.

Will the Labor Market Take a Turn for the Worse?

Benz: When we had you on last time, you correctly predicted that this economic cycle might not resemble the cycles of old where a slowdown leads to sharply higher unemployment. As a matter of fact, the labor market has remained really strong even amid fears of a slowdown. Do you see that markedly changing?

Santoli: I’m not that confident one way or the other on that. I think that there’s probably initially a reluctance to reduce payrolls as much as there would have been in the prior cycles because we’ve just come out of this period of labor scarcity and companies know that. But, I don’t know. I think you’ve been able to see enough moves toward preserving of profit margins, and I think there will be some softening up of labor market conditions. I have to admit I was skeptical of Fed chair J. Powell saying that perhaps we can cool off the labor market just by having job openings come down a lot and not necessarily have unemployment go up much. That’s exactly what’s happened to date pretty much, and I thought that that is plausible but not likely and it was just more importantly the thing he would have said whether he believed it or not at that point. Because if you know things have to get tighter, if you know the economy has got to slow, if you know that the job market is too hot, you’re going to be raising rates and you might as well put it out there and say, I’m not trying to kill the labor market. But my point is that it has been more resilient than they may have anticipated. There was an uptick in labor participation in the latest payroll report, though I’ve seen some work that suggested that it was more attributable to fewer people leaving the labor force than many new people entering it. So, it seems like it will be stickier than in past cycle, but I don’t think that that immunizes us from an uptick in inflation. You’ve seen unemployment claims turn higher to a degree—still at very low levels—but directionally, I think things are inching that way.