Full Employment Reduces Valuation Risk for Stocks

Investors are always filtering the cross currents of Bull and Bear market prognostications flowing from a cornucopia of data. Credible arguments can often be presented on both sides of the ledger. On the negative side we see the downtrends in virtually every macroeconomic indicator and a plethora of proxies, such as inverted yield curves, with impeccable track records forecasting a serious recession. In the positive Bull camp, we have the strongest labor market on record that serves as an iron dome from economic hurricanes. Even negative sentiment and leading indicators are at such gloomy extremes that limit the extremes of further deterioration. The major investment houses are clearly uncertain with their forecasts of an economy that will worsen throughout 2023, but with either skirt a recession or trigger a mild contraction with maybe one more new low in stocks. This brings up the additional question of what is a recession? The National Bureau of Economic Research (NBER), as the official arbiter of recessions, indicates a vague mix of weak data on GDP, employment, income, retail sales and industrial production as an undefined measure. From our perspective, this complicates the question whose answer should rely predominantly upon labor strength and related financial stress of consumers. It doesn’t matter if GDP, manufacturing, and sales contract for ten quarters in a row if there is no stress in the labor market. The bottom line is we have full employment today and relatively stress-free consumers. The Bear market in stocks may have some serious downside tests ahead, but now that the excess stimulus and equity valuation multiples have been ratcheted to normal levels, we should not just assume the slowdown will continue until household loan defaults and unemployment reach normal recession level highs.

One of the canary in the coal mine indicators we love to highlight next to the monthly unemployment number is that of Continuing Claims for unemployment insurance. In economic downturns labor does not lag the economy like it does during upturns, as employers are quick to shed workers when sales and production fall. Previous recessions began when the Claims number rose above 2.6 million. Earlier in 2022, Claims hit record lows of just 1.3 million and are only now at a tight 1.6 million. Along with record low unemployment of 3.5% and 10.5 million job openings, it’s clear there is not much financial stress among workers.

Drilling down a bit shorter term we can see a small rise in jobless claims due to recent mega-cap tech layoffs, but there is no sign that these workers will not be reabsorbed in coming months. With these numbers released weekly, we will have a decent barometer of pending trouble from workers and their related spending habits that could impact earnings and stock valuation multiples. A move well over the December high of 1.7 million Jobless Claims could denote a more worrisome trend, but it will require a number closer to 2.6 million to reach past levels where loan defaults and unemployment accelerated, and recessions were declared.

Another confirmation metric we watch for signs of a severe economic downturn are loan delinquency and default rates. While Automobile loan amounts have gone parabolic along with a strong surge in delinquencies, the default rate remains in the middle of the healthy years of the previous decade. Mortgage rate defaults and even credit card delinquencies are in even better shape near record lows. Bearish analysts point out the continuing record credit card balances being racked up every week and say consumers are about to run out of money. At some point this may be true and curtail spending, but at full employment and strong wage gains today there is no reason yet to expect a collapse in spending and credit quality. The consumer credit card spending rate of change has actually been decelerating for four months and should continue this trend towards the zero-growth line year over year. However, until unemployment moves into the 4 to 4.5% zone, the consumer stress levels will remain modest and buffering future stock investment risk. 

Another way to look at credit risk is with the credit spreads of various categories of corporate debt. This metric was quite negative over the summer as inflation peaked along with rate hiking fears. Since then, inflation expectations have fallen sharply and even high yield junk bond spreads are edging into the normal risk zone. A further drop in Junk option spreads below 4% would be more of a green light for the markets while a move back to the 5 to 6% zone would panic the stock market into assuming that the banking system was encountering problems with their debt quality.

The charts above paint a picture of transition from an over stimulated economy migrating to the bottom of the cycle, while the all-important consumer remains strong financially. How much deeper will this slowdown go and will wheels come off the incredibly strong labor market? There are plenty of signs of trouble out there from manufacturing, consumer sentiment, leading indicators and even the service sector. However, these measures have already fallen to levels that historically coincide with an economy within a couple quarters of a major economic bottom and yet employment income still shows no signs of souring.

Shifting to a more technical perspective, stocks tend to sniff out the economic nadir months in advance. The thrust higher in equity prices over the past 4 months typically signals an end to the Bear market. Most world stock market indices qualify as having entered new Bull markets in January. The chart below illustrates that Consumer Discretionary stocks typically perform worse than the general market during Bear markets, but often lead the way out into Bull market upturns. Since the Bear market lows in October, this sector has moved from negative extremes to slightly positive. Historically, this means that new Bear market lows are less likely and that the market has always been higher one year later.

Moribund housing and semiconductor stocks are now outperforming the general market despite the likelihood of a further decline in Sales growth.


In 2022 the SP 500 Index tried and failed 4 times to sustain a rally above the popular 200 day moving average (dma). This January the SP is once again testing the 200 dma. Should there be an acceleration above this average, it will be yet another sign that the worst is behind us in the stock market. This does not mean stocks are ready for an all-clear Bull market phase ahead, but more likely that our wide trading range forecast is necessary to digest the tougher monetary conditions until inflation rates fall much further. Our main weekly indicators are mixed, which allows price action in either direction near term. Seasonally, we still expect some strength into mid-February with the next serious downside test arriving in March.


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