Back in Session
There are many songs about September — perhaps the most well-known is “September” by Earth, Wind & Fire — a rather upbeat track about memories of dancing under cloudless skies. For the purposes of this week’s blog post, I’ll call this song the bull’s anthem.
I like the idea, and after the year-to-date experience of the S&P up more than 17% and the Nasdaq up almost 34%, it’s tempting to expect the ride to continue in this direction. And it might.
But there’s another well-known song — “Wake Me Up When September Ends” by Green Day — which is a much more somber tune about summer having come and passed, with rain returning. I’ll call this song the bear’s anthem.
I like both songs, and trying to predict how one particular month will shake out is a fool’s errand. So rather than trying to figure out what exactly will happen in September, I’m going to borrow some back-to-school spirit and revisit some of the big concepts we’re faced with as investors going into autumn.
Respect the Cycle
We are currently 17 months into the Fed’s rate-hiking cycle, and 14 months into a 2-yr/10-yr yield curve inversion. There is no exact timeline for when either of those two suggest trouble on the horizon, but the range of historical outcomes suggests that trouble has typically arrived… now-ish.
The typical lag time for when monetary policy actions (in this case, aggressive rate hikes) show their effect on the economy is roughly 12-18 months. And on average, yield curve inversions occur roughly 14 months before recessions begin.
These are not exact numbers, and each time is a little different, but if they’re any guide, we’re in the thick of it. That makes me lean toward the Green Day song rather than Earth, Wind & Fire.
The big concept that I think is especially important to remember right now is the business cycle. We can talk about the differences in circumstances for each cycle, the different catalysts that drive outcomes, and the differing lengths of time each part of the cycle lasts. But at the end of the day, I believe the cycle is the cycle and the phases will continue to occur in this order, regardless of how different or unique certain aspects may be each time.
The topics of debate remain: 1) which part of the cycle are we currently in? 2) how long will it last?
The signals continue to send a clear message, IMO, that we are late in the cycle and have been for a while. Some of the signals I mentioned above (Fed rate hikes and yield curve inversion), others are high inflation, a tight labor market — and down the line, a decline in corporate earnings, contracting manufacturing activity, and a general slowing of growth.
There are also stock market characteristics that tend to show up as the economy overheats and starts to cool — the most straightforward of which is that large-cap equities tend to outperform small-cap equities. If we use the S&P 500 as the large-cap index and the S&P 600 as the small-cap index, large-caps have beaten small-caps by more than 13 percentage points this year. That’s a big spread.
What hasn’t shown up yet, however, is the outperformance of bonds versus stocks. That typically occurs when the economy is decidedly contracting and rates are falling as a result of monetary policy easing. We’re not there… yet.
Got Less Jobs
The next song I’m going to reference might not be as well-known, depending on which generation you fall in, and is called “Why Don’t You Get A Job” by The Offspring. If you know it, I apologize for putting it in your head for the rest of the day. If you don’t know it, look it up so it gets in your head for the rest of the day and we’ll all be in this together.
The chart below suggests that people got a lot of jobs, because the number of job openings per unemployed worker has come down considerably (from 2 to 1.5). That’s partly true, but the reality is that over the last 12-18 months, the number of unemployed people hasn’t changed very much, which means a bigger reason why this ratio has come down is because the number of available jobs has fallen.
Some may say that’s a good thing because the labor market was too tight before and this brings it to a more balanced state. That’s also partly true, but the big concept we need to remember here is that when things get tight, companies have to be more cost-conscious. Labor is one of the biggest costs for most businesses, and is the hardest one to cut. But what they can cut more easily is the number of jobs they’re currently hiring for, which is what seems to be happening, as illustrated below.
The concern is that a reduction in job openings can be a sign of an upcoming increase in job reductions. We are certainly not in the danger-zone right now according to this metric, but the trend is definitely moving down. Until we know how this ends, our eyes should remain keenly focused on changes in labor market dynamics.
We all are, and forever will be, students of the markets. I always loved the back-to-school time of year and still do today. School is back in session, and is sure to make for an interesting start to the academic year, and an interesting ending to the calendar year. Excuse me while I sharpen my pencils.
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