Markets continue to struggle against a particularly uncertain economic backdrop. An early-week rally attempt in the S&P 500 was snuffed out by a September jobs report that was still too strong for the market’s liking. Odd as it sounds, participants are now fixated on economic data for the slightest sign of weakening in the labor market. Stocks are unlikely to put in a bottom until the end of the Federal Reserve’s rate hiking campaign is in sight. Right now, signs continue to point to a tight labor market, robust wage growth, above target inflation, and a higher Fed Funds rate. Over the next few weeks, we will be inundated with economic data and earnings reports that could sharpen the view of the Fed’s trajectory. Participants will be watching with a keen eye, and market performance is likely to remain erratic.
The US economy added 263K jobs in the month of September. This was lower than economists’ estimates but not weak enough to alter the Fed’s course of action. Of greater concern, the labor force participation rate turned lower. It is difficult for wage pressure to ease when the labor pool is shrinking. With wages increasingly the driving force behind inflation, this makes the Fed’s job more difficult. However, there have been subtle signs of easing in other data points. Job openings and job quits are starting to fall from peak levels. These are often early indicators of a softening labor market. Should these trends continue, wage relief might be around the corner.
Over the next few weeks, we will get September inflation readings and, perhaps more importantly, a heavy slate of company earnings reports. These releases will add much-needed color to the state of the economy. Early earnings reports indicate that economic activity is downshifting. FedEx is forecasting a substantial reduction in shipping volume over the next few months, and Nike is dealing with large unsold inventories at retail partners. These weak reports could be a preview of what is to come over the next month. To date, estimates for earnings growth have remained strong. Despite the high odds for recession over the next 12 months, consensus earnings growth estimates are still ranging between 6 and 8%. In a typical recession, earnings decline 30% on average. Analysts are not yet baking in the possibility of a recession. Stock prices are likely not fully accounting for this either. There could be a meaningful adjustment to earnings expectations coming out of the Q3 season.
For now, we continue to take refuge in stocks with strong balance sheets, domestic sales, robust cash flows, visible opportunities for earnings growth, and a commitment to shareholder return. We do not know what the data ahead might bring, but there is always safety in the dividend. We do not define risk as movements in stock prices. For us, risk is having to sell good companies at bad prices to fund an expense. Owning a company that pays a reliable stream of dividends affords an investor the ability to look beyond market prices on a given day. Instead, we can focus on the long-term value that a company is building. In time, the market price should reflect that value.
Preston May, CBE®
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