by Professor Jeremy J. Siegel, Senior Economist to WisdomTree and Emeritus Professor of Finance at The Wharton School of the University of Pennsylvania
I thought the economic reports last week were positive for equities, even though bond yields rose after their very steep decline over the last two months. Data was trending soft recently—not recession level but indicating soft activity. That tone reversed last week.
Jobless claims, our favorite high-frequency indicator, stayed relatively unchanged, indicating labor markets holding in. Then the labor market report last Friday confirmed underlying health. The new jobs number came in pretty much with expectations, except the unemployment rate which dropped from 3.9% to 3.7%.
This drop of unemployment is why bond yields jumped over 10 basis points (bps). Further rises on unemployment to stay above 4% would pressure Jay Powell to react and lower rates faster. Keeping the unemployment rate below 4% can give Powell more cover for keeping rates higher for longer, if he thinks it is necessary to continue the inflation fight. Of course, I think the Fed should be lowering rates because I see inflation trends coming down very well.
Year-over-year wage growth was 4% but given how strong the productivity numbers have come in, this is not inflationary. In fact, unit labor costs are negative this year, so I do not regard data on the labor front as inflationary. I also like that the labor participation rate ticked up one tenth—this brings in further slack and lowers wage pressures. The household jobs report was also very strong, reversing some of the losses in the previous month. Of course, that report is much more volatile because of the smaller sample size.
We also received really good numbers from the University of Michigan Consumer Sentiment surveys. One-year inflation expectations dropped from 4.3% to 3.1%—one of the biggest one-month drops in this survey I have ever seen. The five-year inflation expectations dropped from 3.1 to 2.8%. We know Powell watches these surveys on his inflation dashboards and this is very good news.
This week we will have a lot to report on. Normally, the week after the employment report is pretty quiet, but because the employment data came in so late, this week we have both the Consumer Price Index (CPI), and Producer Price Index (PPI) inflation reports and the Fed meeting on Wednesday.
My quick preview: the CPI and PPI will have no impact on this week’s Fed decision as there will be no change in the Fed funds rate. I also do not see this week’s inflation data impacting the Dot Plots because the Fed members already will have submitted their forecasts. I expect the Dot Plot headlines to still readout as pretty hawkish. We know the Fed funds futures markets are implying three to four 25-bp cuts by the end of 2024. I expect that will not be confirmed in the Fed Dots. But one has to remember that three months ago the Federal Open Market Committee (FOMC) predicted a rise in rates by now, which will be proven wrong this week.
So, a cautionary tale: don't put any credence in the one-year-ahead forecast of the FOMC. Powell will want to keep optionality of raising rates, particularly if there is a hot inflation report. But the data—commodity prices, oil prices and everything else—do not look inflationary.
The primary risk to equities in the first half of 2024 is a Fed that remains too stubborn to see the downward inflation path. If Powell is overly stubborn, we could see up to a 10% correction in the first half of the year, but I expect 2024 to close fairly strong once the Fed finally gets it.
The technicals of the market currently look quite strong and I see December continuing these positive trends. I see the 10-year Treasury not going much below 4% and Fed funds rate down to 3.5% by year end. Given what I see for earnings, I think the equity market is poised to perform well, and while I expect the productivity trends from advances in technology to support real economic growth, there could be a broadening participation in equity markets beyond the Magnificent 7 tech stocks.
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