At the start of the year, we published three themes that I believe will define the equity markets over the coming months. One of them was:
The ideas that “good news is good news” and vice versa will take greater root as investors increasingly recognize the risk of recession and favor economic results that appear to reduce the likelihood one.
We’re only three weeks into 2023, but so far this theme has had a mixed track record. When we sold off on Wednesday, bad news was clearly bad news. Retail sales missed expectations and that set a negative tone for the session. After trying vainly to rally through its 200-day moving average, the S&P 500 Index (SPX) closed about 1.5% lower.
Today, however, we are up just under 1% after Netflix (NFLX) beat on subscriber growth but missed on most other metrics, Alphabet (GOOG, GOOGL) and Wayfair (W) announced significant layoffs, and existing home sales fell to their lowest level since 2010 (though to be fair, they were better than expected). At best this is a mixed bag of news, if not a rally on outright bad news.
There is indeed some logic about a stock rallying after announcing layoffs. It can help a company’s bottom line. If a generally thriving company, like GOOG, lays off a percentage of its workforce, presumably it is shedding its least productive employees or trimming its least productive divisions. In the short-term, costs are reduced and margins are improved. Over the long-term, one has to question whether a company can shrink its way to growth – a question that needs to asked about the unprofitable Wayfair.
Collectively, the wave of recent Wall Street and technology job cuts will have to take a toll. Front office jobs at Amazon (AMZN), Microsoft (MSFT), GOOG and Goldman Sachs (GS) are among the most highly sought. These tend to be high-paying jobs with high prestige, yet we’ve heard about over 40,000 of them being cut. Intuitively, these will be likely to filter into the weekly jobless claims and monthly payrolls, but that could take time. Companies like these tend to offer severance, and many states won’t process unemployment claims until the stated severance period ends, even if the money is paid in a lump sum. Furthermore, the Federal Reserve thinks collectively about labor. A drop of 40,000 jobs, even if they are really good ones, don’t make a dent in the over 10 million openings shown in the monthly JOLTS data. They’re more likely to have a negative influence on consumer spending, especially for more expensive discretionary items, if well-paid people at those firms shut their wallets fearing further cuts.
As before, the question at hand is this: fixed income markets are reflecting imminent interest rate cuts. If we take the Fed at their word, they have no intention of cutting rates almost immediately after raising them. Even if they defeat inflation, why would they want to risk re-stoking it? Thus, that implies the economy would be so weak in the second half of this year that the Fed would need to reverse its restrictive policies. Are equity investors so addicted to liquidity that they would rather root for that scenario rather than a solid economy, even if short-term rates remain stable at higher levels for some time? At some point, investors will need to decide. We’ll know when we see which paradigm – good news/good, or bad news/good – they choose.
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