As jobs get harder to find, stocks could be in trouble after best first half to an election year in half century

 


First, the labor market was too hot for the U.S. stock market. Now it could risk cooling too quickly.

Investors this year have been flocking to a narrow pack of mega-cap stocks for safety, waiting for Federal Reserve interest rate cuts. One idea is that even if the economy sputters, this powerful group of companies will continue to kick off a profit.

But another, more worrying narrative has gained traction in markets around the potential for the jobs backdrop to quickly deteriorate.

“The reason why it is dominating the discussion now, is the pickup in unemployment,” said Kevin Gordon, senior investment strategist at Schwab, pointing to its climb to 4% in May, up from a two-year stint below that level. “Once you do start to see it creep up, it’s pretty hard to stuff that back into the bottle.”

A fear is the Fed might wind up lowering rates to help an ailing economy, rather than cutting rates to establish a soft landing.

Jobs creation averaged 250,000 a month in the first half of 2024, according to Bankrate’s Mark Hamrick, a senior economic analyst. He expects June’s report, due on Friday, to reflect a steady unemployment rate, but weaker hiring.

“If either of these key metrics fails to match expectations, it could raise concerns about the risk of a more significant slowdown in the job market and beyond,” Hamrick said, Friday in emailed comments.

The economy so far has been navigating the Fed’s long road of higher interest rates without blowing a gasket.

The S&P 500 index SPX on Friday booked its best first half to an election year in almost 50 years, providing a positive backdrop for July, typically a very good month for equities.

Yet, within the Fed, views on the labor market’s resilience appear to be broadening out, especially as the ratio of job openings per person has dropped to 1.2, from a peak in 2022 of two per seeker.

“If you rewind three months ago, it was a unified front,” said Roosevelt Bowman, a senior investment strategist at Bernstein Private Wealth Management, of messaging from the Fed. “I do think the unemployment rate is going to be really important to focus on.”

Investors have been watching the jobs market carefully, even though many appear unworried about recession risks this year, with stocks near record highs and credit spreads close to historical tights.

“We are very wary of valuations,” said Luke Tilley, chief economist at Wilmington Trust, of stocks, even while his investment committee is adding to equities, including U.S. large-caps.

Instead of leaning into popular “Magnificent Seven” stocks, which include Apple Inc. AAPL, -1.63%, Amazon.com Inc. AMZN, -2.32%. Alphabet Inc., GOOG, -1.84% Nvidia Corp. NVDA, -0.36% and others, Tilley sees value in the other lagging parts of the S&P 500. He “expects a broadening” of the rally as economic growth slows and inflation further cools, which should open the door to a few rate cuts.

Tilley also cautioned that it took about 18 months once interest rates peaked in 2006 for the economy to falter. “I don’t think there are very many similarities between right now and the start of the 2007-2008 recession, but it’s worth thinking about the fact that after a rate-hiking cycle, it took a long time for a recession to come.”

Matt Stucky, chief portfolio manager, of equities at Northwestern Mutual Wealth Management Company, isn’t feeling as optimistic.

Wall Street has been forecasting the stock market to see double-digit earnings growth this year and next, while Stucky worries about weaker economic data, rising consumer delinquencies, and the Fed’s policy rate holding fast at its highest level in about two decades.

FactSet pegged the latest S&P 500’s earnings annual growth forecast as 11.3% for 2024 and 14.5% the following year.

“This is all supposed to happen when the Fed is intentionally trying to slow the economy,” Stucky said. He thinks investors should instead position portfolios for a mild recession in the next 12 to 18 months. “We think risks are rising.”

Stocks closed lower Friday, but logged monthly gains, with the Dow Jones Industrial Average DJIA up 1.1% in June, the S&P 500 3.5% higher and the Nasdaq Composite COMP advancing 6%, according to FactSet. The Dow closed the quarter lower, while the S&P 500 and Nasdaq rose for a third straight quarter.

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