Last week’s losses weren’t really caused by a sudden shift in fundamentals or a dramatic change the direction of the economy, but instead by a subtle shift in how markets interpret said fundamentals. 

Thursday’s data dump and the market’s confused reaction to it was a good example. That’s the day payroll processor ADP released its estimate of how many jobs the U.S. economy created in December (which, by the way, was generally pretty strong: By ADP’s reckoning, employers added 164,000 new workers last month — more than expected and consistent with sustainable growth, but also not the kind of dangerous acceleration that would catch the Fed’s attention.¹) Coincidentally, that was also the day that Standard & Poor’s released its purchasing managers’ indices for the services sector – the biggest segment of the U.S. economy by far – and found it to still be expanding modestly, effectively side-stepping (for now) fears that it might slip quietly into reverse.² ADP’s chief economist, Nela Richardson, pointed out in her firm’s Pay Insights report that wage growth continued to moderate last month: “any risk of a wage-price spiral has all but disappeared.” ³  

The U.S. labor market seems to be holding up just fine but is no longer looking like it might reignite inflation given the combustible characteristics of runaway wage growth. Meanwhile, growth in the services economy continued to compensate for a contraction of the goods-producing sector the same way it has been for more than a year but has continued doing it in such a way that doesn’t threaten out-of-control growth.  

And yet investors weren’t entirely sure what to do with all that good news. After two days of selling, equity markets started out Thursday by trying to rebound with fairly robust gains but ended the day flat to lower, which suggests one of several conclusions: Either markets have become bored with the “Goldilocks” theme, or they’re finally becoming at least a little more skeptical that the economy can endure 5.25% of rate increases and the quantitative tightening without breaking. I also suspect that the hectic buying of all things risky that took place during the fourth quarter of 2023, which took forward valuations to levels only seen a handful of times since the heady days of the early 2000s mostly behind hopes of “Goldilocks, realized,” may have played a role, too. 

But let’s be clear: It wasn’t all horns and confetti for the economy last week, and anyone – including former Fed Chairs and Treasury Secretaries⁴ – who is declaring that the U.S. has achieved “soft landing” status must still explain away a few inconvenient realities, for instance a still-inverted yield curve and recession-level readings for broad aggregates like the Index of Leading Economic indicators. And, returning our focus to data freshly released last week, the fact that the year-long contraction in the manufacturing sector deepened last month, with new order activity dropping faster than at any point since last summer and both backlogs and inventories being drawn down at a rapid clip.⁵ That places an even greater burden on the services sector to continue pushing the rock uphill. 

Meanwhile, the job market is still unnaturally tight: By the Bureau of Labor Statistics’ read, the unemployment rate fell again last month and payroll growth was once again better than expected.⁶ Last week’s JOLTS report showed some progress by declining to 8.8 million in November,⁷ but there is still more than one job per available worker – a historical oddity that is mostly (though not entirely) unique to the post-COVID era.

That sets up a potential conundrum: Labor markets are probably still too tight to allow the Fed to commence cutting – at least not as quickly and as forcefully as markets are hoping they might. But at the same time, the job market is starting to show troubling signs of weakening from within, perhaps dramatically. Examples we’ve discussed in the recent past include the evaporation of work backlogs left over from COVID and its aftermath, the ongoing decline in temporary employment, and weakness in both aggregate hours worked and overtime hours. This week’s eye-opening additions to the debate came in the form of a declining quits rate inside the JOLTs report and Challenger, Gray & Christmas’ use of the word “plummeted” to describe hiring activity in calendar year 2023, even as it reported a decline in the pace of new job losses in December.⁸

Taken together, all that data might suggest that there may be a rapid and self-reinforcing acceleration in joblessness as we step into 2024 (a prospect made more credible by Challenger’s contention that a bulk of layoffs traditionally occur during the first two quarters of a new year).

But these debates are nothing new: The push-and-pull between the sectors of the economy has been firmly in place since at least the middle of last year, and the simultaneously too-hot-to-cut/potentially-too-cold-to-breathe-easy characterization of the U.S. labor market was equally well-known as 2023 drew to a close. So to recap, we started 2024 with exactly the same questions that we ended 2023 with. The only thing that seems to have changed is how markets seem to be feeling. 

What to watch this week 

As mentioned above, equity market valuations – specifically, forward-looking price-to-earnings multiples – ended 2023 at least a little stretched. Here’s a reminder – there are essentially two ways for earnings multiples to decline to more reasonable levels: either the numerator (stock prices) has to fall, or the denominator (earnings estimates) has to increase. While last week’s returns represent some measure of progress on the former, this week represents the first chance we’ll have to see whether we can expect any relief on the latter. That’s because fourth-quarter earnings season kicks off on Friday, when a whole slate of big banks is scheduled to release results. 

I’ve long believed that banks hold a special place in capital market psyche given what they do for a living: lend to businesses and individuals who then in turn deploy those funds into the real economy to do things like produce and consume. That gives banks and the individuals who run them unparalleled perspective into the status of the economy: A nation’s output can’t grow if its banks aren’t healthy and happy, and here in the early days of 2024, there are signs that they may not quite be either of those things. By Friday, we’ll have a better idea about whether that’s still the case. 

If banks represent a good window into the health of the economy on an ongoing basis, homebuilders may represent something similar at this specific point in time. That’s because a complete collapse in affordability has left housing – which is among the sectors most capable of creating economic growth through the knock-on effects it has on other categories of consumer demand – flat on its back. Now, Powell’s well-telegraphed pivot two weeks ago may have finally helped pop the two-year trend of high and rising mortgage rates. If so, homebuilders will be the first to sense it; tune in to KB Home’s earnings release on Wednesday to see if that’s true.

While earnings will likely capture the lion’s share of investor attention for the next several weeks, there’s still an economic calendar to check in on. This week’s is reasonably light but still features two inflation releases that are worth mentioning – consumer prices on Wednesday and producer prices on Thursday. While I currently believe these two yardsticks have almost exhausted their time in the spotlight, a big surprise in either direction will still command attention. 

Finally, that National Federation of Independent Businesses will release its final read on small-business sentiment for 2023 on Tuesday. Small businesses form the backbone of the U.S. economy (as well as a majority of its output) and are therefore always relevant as a window into the macro. Now, however, exposure to things like labor costs, hiring trends and trends in the services sector makes the NFIB’s survey particularly interesting at this juncture. Tune in Tuesday for their take.