Week in Review: August 5, 2022

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Week in Review: August 5, 2022

Strong jobs data gives the Fed room for faster rate hikes — now all eyes are on inflation

 

Market summary

The S&P 500 and Nasdaq ended the week mostly higher. Sectors were mixed, as growth outperformed value. Treasuries were weaker with the curve flattening and increased volatility, as the 10-Year yield fell to 2.50% on Tuesday and ended the week at 2.84%. The 2/10 spread fell further into negative territory this week, fueled by Friday’s strong jobs report, to a post-2000 low. The dollar eked out small gains following Friday’s jobs report. 

This week   

July’s nonfarm payrolls were much stronger than expected at 528,000, their highest level since February 2020. Payroll gains were broad-based and large in leisure and hospitality at 96,000, in professional and business services at 89,000, and in healthcare at 70,000. The recent growth slowdown in housing and manufacturing did not affect job growth for these sectors, with construction at 32,000 and manufacturing at 30,000, payrolls still materially increased. Services jobs increased by the most in five months, up by 402,000, reflecting a sustained pickup in the services sector in July. The three main drivers of services employment — healthcare and education at +122,000, leisure and hospitality at +96,000, and professional and business services at +89,000 — accounted for 75% of the gain (see Figure 1). 

The unemployment rate lowered to a pre-pandemic low of 3.5%, although the labor force participation rate declined to 62.1 in July. Average hourly earnings rose a strong 0.5% month over month in July, while wage growth held steady at 5.2% year over year. The pickup in the monthly wage gain supports recent data pointing to consistent high wage pressures and will certainly catch the attention of the Federal Reserve (the Fed) officials and put them on a faster hiking track at the September Federal Open Market Committee (FOMC) meeting. 

The labor market continues to defy expectations that a recession is imminent. This week’s stronger-than-expected labor market data provides support for the Fed to aggressively hike interest rates by another 50 or 75 basis points (bps) in September, depending on upcoming inflation and jobs data. If inflation data continues to surprise to the upside or remain at current levels and there’s a strong employment report for August, we’d expect the Fed to raise rates by 75 bps again at September’s FOMC meeting. 

Labor demand moderated in June, as job openings fell for the third straight month, though businesses maintained a strong need for workers as openings came in at 10.7 million, the smallest increase since September 2021. Looking at underlying data, job openings have continued to move lower in the leisure and hospitality sector and started to fall more sharply in both construction and retail; both sectors are sensitive to less purchasing power from rising inflation. Those slower job openings are countered by an elevated level of openings in the services sector notably professional and business services and education and health. Overall, worker shortages remain a persistent pain point, and labor supply will take a while to recover. 

Earlier this week, we received further confirmation that the services sector remains resilient while manufacturing continues to slow. The Institute for Supply Management (ISM) manufacturing index declined less than expected to 52.8, indicating modest growth for July. Underlying data was mixed as the new orders index slipped for the second consecutive month; however, pricing pressure rose at its slowest rate since August 2020. The combination of high inflation, higher interest rates, slow supply chains and less purchasing power for consumers will make manufacturing demand more fragile. Meanwhile, the ISM services index increased to 56.7 in July, with a broad-based rise in the underlying components. The underlying details of the report reveal improving supply chains and easing inflationary pressures, relative to June. We expect the rotation from manufacturing to services to continue as consumers seek more experiences; however, the growth in services is likely to slow as inflation and negative sentiment take a toll (see Figure 2). 

Earnings Outlook

Second-quarter earnings season is wrapping up, with nearly 90% of S&P 500 companies having reported. Results have been positive, with both sales and earnings for the quarter exceeding earlier estimates and year-over-year growth trending toward 6.8% and 13.6%, respectively. However, some concerning trends have emerged. Energy has accounted for a disproportionate share of growth. If you exclude the energy sector earnings growth, S&P 500 earnings actually fell 3.8%; meanwhile, downgrades for estimates in upcoming quarters now outnumber upgrades. Moving forward, we expect earnings to come under increased pressure given tighter policies and slowing growth.

Going Forward

Equity and bond market volatility will remain elevated, until the future path of inflation is more certain and markets become comfortable with a data-dependent Fed. We remain defensive in our positioning, as we view greater risks to corporate earnings as growth slows, and we’d use periods of strength as an opportunity to reduce overexposed risk positions. Within equities, we continue to favor U.S. Large Cap exposure, since economic growth is rapidly slowing in Europe as an energy crisis looms, and China’s strict COVID policies have weighed on manufacturing. Within U.S. Large Caps, we continue to advocate for a defensive positioning in equities, favoring segments exhibiting quality and yield. In fixed income, we remain short duration and higher credit quality in our positioning. Credit spreads will continue to leak wider to account for recession risks.     

 

THE WEEK AHEAD

  • July’s National Federation of Independent Business (NFIB) Small Business Index will be released on Tuesday. 
  • July’s CPI is expected to decline to 8.7% year over year and will be released on Wednesday.
  • August’s Michigan Sentiment index is expected to increase to 53 and will be released on Friday.
     

Figure 1: U.S. nonfarm payroll employment

   nonfarm payroll

Sources: Bureau of Labor Statistics and First Republic Investment Management. Data as of August 5, 2022.

Figure 2: Contribution to headline ISM Services 

          ISM services
Source: Oxford Economics/Haver Analytics, Institute for Supply Management, First Republic Investment Management. Data as of August 5, 2022.

 

 

Market Returns (USD) as of 8/4/2022

1-Week

Quarter-to-Date

Year-to-Date

1-Year

Global Equities

MSCI All Country World

 
1.7% 7.5% -14.2% -10.7%

S&P 500


2.0% 9.8% -12.1% -4.3%

Dow Jones Industrial Average


0.6% 6.4% -8.9% -4.1%

NASDAQ


4.6% 15.4% -18.3% -13.3%

Russell 2000


1.8% 11.7% -14.5% -12.1%

First Republic Founders Index

 
5.4% 16.8% -21.3% -24.4%

Russell 1000 Equal Weighted


1.1% 8.6% -9.1% -4.2%

MSCI EAFE

 
1.4% 5.3% -15.3% -15.2%

MSCI Emerging Markets

 
-0.2% -0.1% -17.7% -21.6%

Fixed Income

ICE BofAML Municipals 1-10 Year A-AAA 

0.3% 2.1% -3.7% -4.1%

Bloomberg Barclays Intermediate Government/Credit

-0.1% 1.5% -5.4% -6.7%

Bloomberg Barclays High Yield Bond

1.6% 6.8% -8.3% -7.0%

Market Levels

Thursday

Week Ago

Year End

Year Ago

S&P 500


4151.94 4072.43 4766.18 4402.66

Dow Jones Industrial Average

 

32726.82 32529.63 36338.3 34792.67

10-Year U.S. Treasury Yield (Constant Maturity)

2.67% 2.68% 1.51% 1.17%

Gold ($/oz)


$1,791.21 $1,755.84 $1,821.90 $1,812.00

Crude Oil ($/barrel)


$88.54 $96.42 $75.21 $68.15

U.S. Dollar / Euro ($/)


1.02 1.02 1.14 1.18

U.S Dollar / British Pound ($/£)


1.21 1.22 1.35 1.39

Japanese Yen / U.S. Dollar (¥/$)


133.14 134.27 115.16 109.56

Bitcoin Futures ($/XBT)

 
$22,455.00 $24,033.74 $47,977.03 $39,840.00