Weekly market wrap

The labor market is clearly softening, but still not collapsing

• The U.S. labor market was a key focus point for investors last week, with Friday's August nonfarm jobs report perhaps being the most highly anticipated data point of the week. Overall, the jobs report confirmed signs of a weakening U.S. labor market — with a drop in the unemployment rate from 4.3% to 4.2% offset by a clear softening trend in new jobs added and several downward revisions. After the soft jobs report, markets continued a sell-off that began in the seasonally volatile month of September. The S&P 500 is down about 4% from recent highs but remains higher by more than 13% year to date. In our view, the slowing labor market certainly adds risk to the economic outlook, but the figures thus far don't point to an imminent collapse or recession.
   
• Markets now turn their attention to the path of the Federal Reserve, and how recent softer labor market data, combined with softer inflation readings, could impact potential interest rate cuts. While we still believe the Fed will begin its rate-cutting cycle Sept. 18 with a 0.25% rate cut, the probability of a 0.50% rate cut has increased, given the recent softening economic data. The Fed will also provide an updated set of economic projections and a new "dot plot," which outlines FOMC (Federal Open Market Committee) members' best guess at future rate cuts as well. We believe the Fed will be ready and willing to support the labor market and could set the stage for potential outsized rate cuts as needed.
   
• Overall, markets have had a strong run this year through the end of August, with the S&P 500 up about 18% during that time frame. We are now entering a seasonally choppy period for markets in September and October, followed by U.S. elections on Nov. 5. Given the uncertainty in the economic (and political) environment, we could perhaps see a correction in markets materialize in the typical 5% to 10%+ range in the weeks ahead. Yet to us, the fundamentals still support the ongoing market expansion: Inflation is moderating, the Fed is poised to cut rates and economic growth, while cooling, does not yet seem negative or recessionary. In this backdrop, we recommend long-term investors lean into market weakness and consider rebalancing portfolios, diversify, or add quality investments at potentially better prices, as we believe economic growth could reaccelerate in the 12 to 18 months ahead.

Recent labor market data has been weakening — although it’s still not recessionary

The U.S. labor market data last week could be summed in on word: weakening. We saw this earlier in the week in the job openings data, which fell to around 7.7 million, the lowest level of the year, as well as in the ADP private employment data, which indicated new jobs added of just 99,000, also at the lowest level since 2021.¹ And perhaps the most anticipated labor market report of the week was the U.S. nonfarm jobs report, which reflected a similar weakening trend. New jobs came in at 142,000, below the expected 165,000, and the past two month's figures were revised lower by 86,000, bringing the three-month average job gains to a more subdued 116,000, well below the average of around 334,000 over the past three years.¹

Underneath the surface, there were notable shifts in sector trends for new jobs as well. The manufacturing sector was particularly weak, losing 24,000 jobs, versus expectations of losing 2,000. This comes as the ISM Manufacturing survey data last week also indicated that the U.S. manufacturing sector remained in contraction. Meanwhile, the sectors with the largest jobs gains were in the services economy, including leisure and hospitality, education and health services, and government sectors.² But job growth in all three of these areas was lower than the gains we saw last year, signaling perhaps that peak job growth even in services sectors may be behind us.

There were, however, some silver linings in the U.S. jobs report. The unemployment rate, for example, did tick lower from 4.3% to 4.2%. While this is still above last year's lows of 3.4%, the unemployment rate remains well below the long-term average of a U.S. unemployment rate of 5.7%. Also, the unemployment rate has moved higher in large part because new entrants have come into the workforce, not because layoffs or job losses have climbed meaningfully. Finally, although the 142,000 jobs added last month were below expectations, they do remain in line with the 10-year pre-pandemic average of around 180,000. This to us indicates that while the labor market is softening, we are not yet at negative job growth or recession-like levels.¹

Markets have been taking on a more defensive posture as we enter September

Markets have taken on a clear risk-off tone since the start of September, in part driven by the rising uncertainty in the labor market and economic data, and in part perhaps driven by a natural pause or period of profit-taking after a strong rally. We are seeing more defensive posturing across several financial markets, including stock markets, bond markets and commodities markets:

• Stock markets rotate defensively: Thus far, for September, we have already seen about a 4% pullback in the S&P 500. However, the sectors that have outperformed most are consumer staples and utilities, both considered defensive sectors that can hold up well in a period of economic slowdown.

• Treasury yields move lower, while yield curve un-inverts: More recently, we have seen Treasury yields across the board move lower, in response to weaker labor market data as well as the potential for Fed rate cuts. Notably, the yield curve (10-year Treasury yield minus 2-year Treasury yield) has turned positive in recent days after remaining in negative territory since mid-2022. This un-inversion of the yield curve, however, tends to occur as the Fed is poised to cut rates and when the economy is softening.

• Crude oil prices hit new lows of the year: The S&P Global Commodity index has also hit new lows of the year, driven in part by WTI crude oil prices, which are now around $68 per barrel. The sell-off in oil and commodities also reflects the fears of a demand slowdown globally, particularly in the Chinese market, which has been plagued with weakening consumer and economic growth.

Markets are clearly expressing more caution across asset classes, perhaps rightfully so after a strong rally and weakening economic data. But keep in mind that investors have gone through similar growth scares in recent weeks, which have subsequently been put to rest as U.S. economic data has been resilient. In addition, as sentiment weakens — perhaps from over-extended or very bullish levels — it lowers the bar for economic data to surprise to the upside and puts market in a better position to recover on the back of better news flow.

The Fed will begin its rate-cutting cycle in September, and may prep the markets for larger cuts to come

Perhaps one potential driver of better market sentiment ahead could come from the Fed, in the form of rate cuts and supportive commentary. The Fed has made it clear that it is now more squarely focused on the labor market side of its dual mandate (which includes both stable prices and full employment). In fact, at last month's Jackson Hole symposium, Fed Chair Jerome Powell noted, "We do not seek or welcome further cooling in labor market conditions." Given the further weakening of the labor market last month, the Fed arguably remains poised to offer support to help bring job market stability.

In our view, the Fed will likely cut rates by 0.25% at the September 18 FOMC meeting, bringing the fed funds rate to 5.0% – 5.25%. If market conditions deteriorate substantially between now and the Fed meeting, a 0.50% rate cut may become more likely. In addition, Powell may signal in his press conference the cadence of rate cuts and why outsized rate cuts could be appropriate going forward. Overall, we would expect the Fed to signal unequivocal support for the labor market and economic growth, which may be a welcome shift in tone for markets.

Next week investors will also digest the last set of consumer price index (CPI) inflation readings before the Fed meeting. The expectation is for headline CPI inflation to continue to moderate, down from 2.9% year over year to 2.6% this month, making further progress toward the Fed's 2.0% target. Over time, the combination of easing inflationary pressures and lower interest rates could support a reacceleration of consumer and corporate spending.

Stock markets will likely remain volatile, but if the Fed can pull off a soft landing, lean into any weakness

Overall, markets have rallied sharply for the first eight months of the year, with the S&P 500 and technology-heavy Nasdaq up about 18% through August. We are now headed toward a seasonally weaker period of September and October, followed by U.S. elections on Nov. 5. Given the uncertainty in the economic data (as well as political uncertainty), combined with the strong rally earlier this year, we could expect some form of a market pause or correction in the weeks ahead. Thus far, the S&P 500 has sold off about 4% this month, driven by underperformance from some of the winners of the past year, including the technology and communication services sectors.

Yet, the fundamentals still support an ongoing market expansion: Inflation is moderating, the Fed is poised to cut rates, and economic growth, while cooling, does not yet seem negative or recessionary. For long-term investors, we recommend leaning into market weakness, especially as lower interest rates mean better borrowing costs for both consumers and corporations ahead and could ultimately lead to a re-acceleration of economic growth. We continue to favor large-cap and mid-cap U.S. stocks and recommend sector diversification beyond mega-cap technology, including in areas like utilities and industrials, both of which can do well in a lower-rate environment. For investors with outsized positions in shorter-duration cash-like instruments, including CDs or money-market funds, keep in mind that reinvestment risk is rising as interest rates are poised move lower. We favor gradually extending duration in investment-grade bonds, especially as Fed rate cuts seem likely in 2024 and through 2025.

Mona Mahajan
Investment Strategist

^{Sources: 1. Factset, 2. Bureau of Labor Statistics (BLS)}

Weekly market stats

^{Source: FactSet, 9/6/2024. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results. *Morningstar Direct 9/8/2024.}

The week ahead

Important economic releases this week include CPI inflation and consumer sentiment data.

Review last week's weekly market update.