HIGHLIGHTS:
- Financial markets may be in a “good news is bad news” type of cycle.
- Higher-than-expected jobs numbers and rising wages were met with a 1 percent decline in the S&P 500 Index.
- The Fed is laser-focused on reducing inflation and higher rates are very likely in store.
- US markets will likely adjust to a more aggressive Federal Reserve.
In the world of capital markets, we are often left trying to reconcile good news with bad markets. Like a plant with too much fertilizer, markets often wilt in reaction to good news, or vice versa. The market recovery we enjoyed from late June through early August was a pleasant change of pace, but it may have gotten ahead of itself. While the indications of peak inflation coupled with better-than-expected economic activity remain in place, the significant retreat over the last three weeks suggests we are now in a “good news is bad news” market cycle—and that merits explanation.
For instance, we’ve seen some very encouraging news on the employment front, followed by a very negative move in equity markets. Last Friday, the Bureau of Labor Statistics reported a higher-than-expected 315,000 jobs were created in August, with wages rising at a 5.2 percent annualized pace. Yet, the equity markets threw a wet blanket over the news, with the S&P 500 declining about 1 percent. On the positive side, while there are still more jobs available than job seekers, that gap is shrinking, and a more normal balance may be in sight. That said, the upward pressure on wages remains a factor that challenges both corporate profits and inflation expectations. With the Federal Reserve laser-focused on reducing inflation, the good news quickly translated into further evidence that additional tightening will be necessary, undermining hopes for an easier ride in the coming quarters. As the Fed seeks to reassert its credibility, markets have received a clear message that interest rate policy will not shy away from efforts to reduce inflation—including raising rates higher than expected and holding them in place as long as necessary. This is also, in a way, good news. The alternative could be entrenched inflation in a new normal range of 4 to 6 percent. Sharper efforts now should ultimately be helpful as we trade near-term pain for long-term benefits.
Compared to global markets, the US may be a bit ahead of the game. Higher interest rates have strengthened the US dollar and attracted savings but have made US exports less attractive. Despite uncomfortably high gas prices, energy independence has helped insulate domestic consumers from some even steeper challenges others are facing abroad. In Europe, utility bills are skyrocketing as energy supply constricts ahead of higher winter demand. Spending within the US, from consumers, corporations, and government entities, will likely remain on track to deliver positive GDP growth for the year, even as we still feel the hangover from the first half. Although uncertainty can sometimes make good news into a headwind, we expect markets to adjust to a more aggressive Federal Reserve and move forward again soon.
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