The Game Isn't Over

by Brian S. Wesbury ā€“ Chief Economistm & Robert Stein, CFA ā€“ Deputy Chief Economist, First Trust Portfolios

At the beginning of the season, not many predicted that the Philadelphia Eagles would be in the Super Bowl this year. Ā But, they had a fantastic season and are favored over the Kansas City Chiefs. Ā Predicting this economy is equally hard. Ā Anyone who thinks they know exactly how things will turn out is fooling themselves. Ā COVID policies ā€“ lockdowns, massive borrowing, and money printing to pay people not to work ā€“ have never been tried before. Ā So, what happens is still up in the air.

It seems like just yesterday that ZeroHedge ā€“ with help from the Philadelphia Fed ā€“ was trying to convince people that job growth was non-existent in the second quarter of 2022. Ā Never mind the fact that they purposefully conflated two different measures of jobsā€¦it just wasnā€™t true.

So, it must have come as a shock to those who believed that nonsense that in January, after the equivalent of 17 quarter-point Fed rate hikes, jobs data and hours worked exploded to the upside. Ā Nonfarm payrolls rose 517,000 jobs, while revisions to prior months added an additional 71,000.

Not one economics group came even remotely close to getting this number right. Ā And the print was especially surprising after seeing retail sales fall 4.3% and industrial production fall 5.2%, at three-month annualized rates, through December.

The difficulty of forecasting in this environment is absolutely astounding. Ā On the one hand, the M2 measure of money has contracted in the most recent twelve months (the first time in more than sixty years), after growing over 40% in a two-year timespan. Ā On the other hand, even with the Federal Reserveā€™s sharp rate hikes, the federal funds rate is still below inflation.

Using M2 growth, alone, and Milton Friedmanā€™s lag of 6-9 months, we should be seeing the economy begin to slow, which is what retail sales, industrial production, housing, and retail auto sales have been pointing to. Ā And so far with 256 out of the S&P 500 companies having reported, profits are down 3.1% from a year ago.

But itā€™s not just M2ā€¦the rebound from COVID lockdowns is over. Ā Stores are back open, airplanes packed, and hotels filled. Ā Now that we are back to ā€œnormalā€, how much further can things go? Ā We arenā€™t going to have two packed-stadium Super Bowls this year, just one. Ā And pandemic unemployment checks and PPP loans have run their course. Ā Yes, some state and local governments, and school districts, have money left, but not much. Ā To our way of thinking, we should see a slump now that the drugs of all the borrowing wear off.

So, how then did jobs provide such a large upside surprise!?! Ā Do employers really know what they are doing? Ā Do they see something that is not showing up in the data? Ā Or is this a delayed reaction (after all, employment is a lagging indicator) to issues with hiring during and after the pandemic.

If you couldnā€™t hire workers, but now they want to work, and you expect a soft landing (or even no recession at all) then you grab all the workers you can, when you can. Ā But if there is a ā€œhard landingā€ profits could be squeezed even more.

Taking all this into consideration, we donā€™t think the boom in nonfarm payrolls is a signal worth following. Ā Many companiesā€¦Peloton, Bed, Bath & Beyond, Hasbro, and lots of tech stalwarts were winners when services were locked down and people with fresh stimulus funds needed tech. Ā But now they are all in either financial trouble or are laying off workers. Ā The losers during the lockdowns (services) have all reopened, but people arenā€™t going to double their use of services, especially with interest rates up and money supply down.

So, while one number from one month seemed to change a lot of peopleā€™s minds about the economy, we think weā€™re far from the final whistle of the game. Ā This one isnā€™t over yet.

Unprecedented actions on the scale that we experienced in 2020-2022 will bring unexpected results in 2023. Ā So, while we never want to ignore a number like the January jobs report, we have to question how much is signal and how much is noise.

The economy is still absorbing the money printed during the pandemic. Ā Inflation has not been eradicated, the Fed is highly unlikely to loosen policy anytime soon, and earnings are likely to fall as all the stimulus wears off. Ā Thatā€™s not a recipe for a simple forecast or a soft landing. Ā Like the Super Bowl, until the game is played no one knows exactly what will happen. Ā Count us less bullish than conventional wisdom.

Brian S. Wesbury ā€“ Chief Economist

Robert Stein, CFA ā€“ Deputy Chief EconomistĀ 

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