Why Jobs Report Is Too Hot For The Markets (NYSEARCA:SPY)

Stock market buying momentum weakened when the U.S. Bureau of Labor Statistics posted a blowout jobs report. Markets shun reports of a strong economy or healthy employment. These data points encourage the Federal Reserve to keep raising interest rates. When rates rise, stocks are less attractive. Investors could hold risk-free cash and likely earn better returns. For stocks valued by future cash flow, a higher discount rate decreases the value of money in the future compared to today.

Strong Employment Situation

The BLS posted nonfarm payroll employment rising by 517,000 in January, thanks to hiring in leisure and hospitality, professional and business services, and health care. Employment increases in government also helped lift the figure.

The unemployment rate of 3.4% hasn’t changed by much since early 2022. Similarly, the labor force participation of 62.4% did not change.

Markets appear increasingly fearful of the Fed after the healthy job report. The economy is so strong that companies need to hire more staff. This might pressure markets to rethink when rate hikes will pause and when the pivot begins. Currently, the Fed will likely raise rates by 25 bp in each of the March and May meetings. It will start cutting rates no earlier than 2024.

Investors should watch two exchange-traded funds closely. Apple (AAPL) and Microsoft (MSFT) are the top holdings in the S&P 500 (NYSEARCA:SPY) ETF, as of Feb. 3, 2023. The market accepted that the unfavorable foreign exchange and a supply disruption caused Apple’s iPhone sales to miss expectations. CEO Tim Cook touted artificial intelligence as Apple’s major focus.

After C3.ai (AI) and SoundHound AI (SOUN) gained 160% or more in the last month of the mention of AI, Apple’s attention to its disruptive potential is a positive development.

For dividend income investors, Schwab Strategic Trust – Schwab U.S. Dividend Equity ETF (SCHD) is the ETF to watch closely. The higher rates rise, the more pressure that dividend income stocks feel to return better yield. In March, Schwab will review its composition annually and rebalance quarterly. In March, investors should review what companies the ETF adds and removes.

After SCHD traded from a $68 low in October 2022 to around $77, investors could consider an entry price of around $70. A yield of 3.65% is more attractive than the current 3.31% level.

Revisions to Establishment Survey Data

Immediately following the introduction in the press release is a key technical note.

The survey counts jobs covered by the Unemployment Insurance tax system. The industry classification changed from the 2017 North American Industry Classification System (“NAICS”) to NAICS 2022. Retail trade and information sectors are a major revision. The mining and logging, manufacturing, wholesale trade, and financial activities, are minor revisions.

The change means that investors cannot take the job gains at face value. The comparison from past job reports is no longer the same.

Upward Revision

The BLS also revised the total nonfarm employment level for last year, March 222, by 568,000. The Y/Y change in employment for March 2022 rises from 6.425 million to 7.096 million (seasonally adjusted).

Strong jobs last year indicate that the Fed underestimated the impact of the employee shortage. The pandemic increased the pace of job allocation distortion. For example, technology companies hired too many workers as demand for stay-at-home solutions evaporated.

Interpretation

Persistent inflation is decreasing the affordability of goods. People need to not only return to work but have a second or a third job. The Fed will need to keep a hawkish narrative to slow the economy.

Investors should exercise greater caution with technology stocks. They are a leading indicator of the market’s valuation. After FANNGM posted poor results, the rally among them could fade.

Meta Platforms (META) is a special case. It authorized an aggressive $40 billion buyback. This exemplifies the company’s belief that the stock is likely undervalued.

Amazon (AMZN) fell after posting just three cents a share in non-GAAP earnings. However, the Q4 net income included a $2.3 billion pre-tax valuation loss from its Rivian Automotive (RIVN) holding.

Microsoft (MSFT) posted revenue growing by only 1.9% year-on-year to $52.7 billion. Growth in its Azure cloud business may stall in the next fiscal year.

Alphabet (GOOG) (GOOGL), whose Google unit depends on advertising, posted revenue growing by only 1.0% Y/Y to $76.05 billion. The disruption risk from ChatGPT is a concern. In response to the existential threat, Google is investing $300 million in AI start-up Anthropic.

All of the aforementioned firms depend on the economy heading higher. The Fed’s next rate hikes and hawkish tone will slow the markets, however.

Your Takeaway

Stock markets do not welcome the hot jobs report. The economy continues to need more workers that are in short supply. This would put pressure on wages, which adds to inflation. It will force the Fed to remain in rate- tightening mode.