Stocks & Bonds Start The Year Lower

Major stock market indices fell today (Dow -696 pts; SPX -1.5%; Nasdaq -1.6%) and are broadly lower in the new year. The VIX Index, commonly seen as fear gauge for traders, rose to nearly 20. Gold surged about 1% today. But before you assume this was a conventional risk-off session, know that the bond market sold off across the board by roughly -.3% to -.6%. Bond yields floated upward to account for higher inflation expectations.

Over the past week we’ve gotten more data confirming ongoing strength in the labor market. First, we found out—courtesy of the JOLTS report—that the number of open job positions throughout the US climbed back above 8 million in November, compared with only about 7 million unemployed people.

Next, job growth was stronger than expected in December. A net total of 256,000 new jobs were created during the month vs. about 165,000 expected. The unemployment rate ticked back down to 4.1% and the underemployment rate fell to 7.5%–both considered very low. Other metrics like labor force participation rate and average work week were stable. Finally, wage growth decelerated a bit to 3.9% from year-ago levels, but remains above pre-Covid levels around 2-3%.

This is good news, right? Low unemployment plus strong wage growth equals happy consumers who can keep spending on goods & services that keep the economy going. That’s all true. However, stocks and bonds sold off in the wake of the jobs announcement, especially as it came out alongside a University of Michigan survey suggesting that US inflation expectations have accelerated to 3.3%. That’s a long way from the Federal Reserve’s 2% target.

Thus, traders were spooked by the idea that strong economic growth could reignite inflationary pressures and force the Fed to keep interest rates at elevated, or “restrictive” levels. Some wonder whether we’ll see any rate cuts in 2025. And it’s not just the Fed’s short-term policy rate; we’ve seen both consumer & business lending rates climb over the last several months. This hasn’t yet posed a significant problem for business activity or consumer spending, but it could one day.

Maybe investors are just a little edgy about the possibility of a Fed policy error down the road. I think it should be said that the Fed did a magnificent job engineering a soft landing for the economy while attacking 2022’s inflation crisis. The Fed’s credibility among investors is certainly intact. Still, officials aren’t infallible. Should the economy begin to materially weaken, keeping the policy interest rate at 4.5% could compound the problem. Indeed, most recessions result from this kind of scenario.

Back let’s get back to the present. The media would have you believe that today’s market declines are somehow ominous and prescient. I doubt it. Day-to-day market swings are often the result of short-term knee-jerk trading to make a buck rather than to express a long-term, well considered investment thesis. Also, these concerns aren’t new. Investors have been obsessively focused on the tug-o-war between rates and inflation for the past 3 years, and, by the way, have consistently underestimated growth.

My bottom line is that good news is still good news. A strong economy is preferable to a weak one. And after all we’ve been through, the Fed should get the benefit of the doubt.