Market players are panicking as a result of trouble in Japan and this morning’s nonfarm payroll report that depicts rapidly deteriorating labor conditions. Yesterday, we wrote that hysteria was setting into investor sentiment, and today is just another day of indiscriminate selling on Wall Street. Meanwhile, west of the Mississippi at the Las Vegas Money Show, investors and clients alike have continuously asked me if the Fed is too late in lowering rates. Indeed, with low- and middle-income consumers depending on paychecks to sustain spending habits, how could earnings and the economy grow if this vulnerable segment of the population begins to lose jobs? The July unemployment rate jumped 20 bps to 4.3% and is yelling alongside Treasurys and heavy put option activity that a recession is right around the corner.
Unemployment Spikes
The softening of the US labor market showed no signs of easing in July with nonfarm payroll growth falling significantly below expectations and last month’s results while unemployment increased for the fourth consecutive month. In July, nonfarm payrolls climbed by 114,000, missing the expected increase of 176,000 and falling from June’s downwardly revised level of 179,000. The gain in average hourly earnings also weakened, climbing 0.2% month over month and 3.6% year over year (y/y) compared to analyst’s expectations of 0.3%, and 3.7%. In June, the metrics advanced 0.3% m/m and 3.8% y/y.
In a continuation of last month’s trend of non-cyclical sectors fueling labor market expansion, more than half of recruiting activity was from the combination of the private education and health services category, which added 57,000 individuals to payrolls, and government, which expanded by 17,000 jobs. Within government, local education expanded by 26,200 but the gain was partial offset by a decline in non-education local government payrolls. Among sectors that contracted, information had the largest decline, surrendering 20,000 jobs. Other decliners included the financial activities category and professional and business services, which lost 4,000 and 1,000 jobs. Losses in those categories were more than offset by the private service-providing category increasing by 72,000 positions and construction gaining 25,000 workers.
Tech Disappoints as Consumer Spending Weakens
Big tech companies are reporting a slowdown in some areas of consumer spending, but businesses are continuing to increase their advertising. Meanwhile, the race to build products for artificial intelligence has produced its first bloodshed, with shares of Intel falling nearly 30% this morning. Consider the following quarterly earnings highlights:
- Amazon’s (AMZN) earnings per share (EPS) exceeded the analyst consensus estimate but its revenue was weaker than expected as online sales and cloud computing results disappointed investors. The company’s current-quarter guidance also fell short of expectations, and shares of the retail juggernaut declined more than 9% in early trading. Online sales grew 5% y/y with North American results falling short of the company’s internal goal. Finance Chief Brian Olsavsky echoed an observation by home goods retailer Wayfair: customers are being cautious with their spending. They are also downgrading to lower-priced items. He added that customers are distracted by world events, such as the Olympics and the attempted assassination of Donald Trump. In a potential sign of optimism within the business community, online advertising revenue climbed 20% y/y, placing Amazon among other tech companies such as Meta, Alphabet and Snap that have generated double-digit gains with their marketing services. Amazon’s cloud computing service almost matched the growth rate of advertising revenue. The company’s forecast revenue growth of 8% to 11% during the current quarter, with the midpoint of the range falling below analysts’ expectations.
- Apple (APPL) reported mixed results, including a 2% decline in revenue from Apple Watches, headphones and home speakers as well as a 1% drop in iPhone sales. Overall results, furthermore, weakened significantly in China, Taiwan and Hong Kong where rivals such as Huawei are competing for customers. On a positive note, growth in sales of iPads and services, such as Apple TV+, cloud storage, streaming music and Safari, helped the company’s overall revenue climb 5% y/y. The metric and Apple’s earnings per share both exceeded analyst consensus expectations. The company expects to generate similar overall growth in the current quarter.
- Intel (INTC) shares collapsed nearly 30% this morning after the company reported earnings that fell substantially below the analyst consensus expectation and said it would lay off 15% of its workers as well as suspend dividends in the fourth quarter. At a time when many chip manufacturers are reporting strong sales growth driven by demand for artificial intelligence products, Intel said its revenue dropped 1% y/y and when including one-time expenses, it experienced a loss per share of $0.38. It anticipates a current-quarter loss per share of $0.24. According to CNN, CEO Pat Gelsinger said the company has yet to benefit from the trend of AI boosting demand for computer chips.
A Bad Day for Risk Assets
Risk assets are getting hammered on the back of joblessness worries and investors no longer reacting to negative economic developments favorably. Equity indices are selling off across the board with the Russell 2000, Nasdaq Composite, Dow Jones Industrial and S&P 500 benchmarks sinking 3.4%, 2.4%, 2% and 1.9%. Sectoral breadth is awful with 9 out of 11 segments pointing south on the session as consumer discretionary, technology and energy dive 3.6%, 3.1% and 2.8%. The defensive consumer staple and cyclical real estate areas are the only gainers, as traders hide for cover in names that are insensitive to economic weakness and stocks that benefit from an increasingly achievable housing affordability situation thanks to cratering rates. Furthermore, Treasurys are down a whopping 24 and 17 basis points in bull steepening fashion across the 2 and 10-year maturities, which are changing hands at 3.9% and 3.81%. We wrote last week that when these two rates meet, trouble is a near certainty, and we’re definitely seeing rising odds of further downside in equities. The dollar is also tanking as rate watchers raise the odds of a 50-bp reduction in September rather than a traditional 25. It’s depreciating relative to all of its major counterparts, including the euro, pound sterling, franc, yen, yuan and Aussie and Canadian dollars. Commodities are mixed though, with copper and lumber gaining 0.8% and 0.3% on improved outlooks for manufacturing and real estate. Meanwhile, WTI crude oil, gold and silver are lower by 4.4%, 3.8% and 0.7%.
The Bears Have Legs
The steepening of the yield curve coinciding with late-cycle economic dynamics is a quintessential signal of an equity market correction. Occurring simultaneously, however, are headwinds in Tokyo, sluggish activity in Beijing, disappointing artificial intelligence prospects, geopolitical uncertainty and a hot election season. To add to the list, the third quarter is the worst from a seasonal perspective, and should we enter recession in the next few months, a 25% equity drawdown is in the cards. I’ve previously expected a decline of up to 15%, but the path to more downside has opened up. Firms are not going to make the numbers, similar to 2022, when most of Wall Street yelled no recession but earnings declined. What’s different from that period, however, is that the job market held up and we saw more of an affordability recession in the accounting rather than a traditional one like we see in the Great Depression movies when folks are standing in line looking for work. This time though, the probability of recession has risen to 65%, and we will likely experience a deterioration in profits as well as an announced downturn, as the unemployment rate ticks up to 6.5%.
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There is NO WAY unemployment is going to 6.5%. Who wrote this article?
Well, okay, at some point, it will be over 6.5% again. But the last two times it occurred were due to 1) The financial crisis resulting from the collapse of the housing bubble– unemployment stayed above 6.5% for six years, from 2008-2014; and 2) The sudden plunge in economic activity from the Covid pandemic in 2020. So it would take something really bad for unemployment to get above 6.5%. Regardless of the unemployment rate, I do agree that the S&P is a lock to see 4500 again.