Despite continued gains in employment, year-end numbers showed signs of significant weakness in business activity.
The Week That Was
Year-end economic data show the economy abruptly shifting away from moderate growth.
Two key December business surveys point to a downturn in economic activity. The more bearish S&P survey points to significant weakness, with a reading of 45, and the ISM survey registers a 49, slightly below the break-even level of 50.
The December ISM survey for service companies dropped sharply from the prior month. New orders fell to 45, a steep decline from 56 the prior month. This last reading is similar to the S&P survey that already indicated weakness.
In contrast to the business surveys, the December jobs report shows a gain of 220,000 private payroll jobs. Business surveys agree that businesses are still hiring. Ongoing labor shortages are listed as the main reason.
As new orders continue to decline, more businesses will soon be forced to lay off workers. Look for there to be fewer job openings in the months ahead.
Things to Come
The main news this coming week will be Thursday’s December Consumer Price Index number. Expectations are for little if any inflation for either the total or core numbers. A sharp 9 percent monthly decline in oil prices to $76 should help hold the line on year-end
inflation.
Even with another month of good inflation news, yearly inflation will remain uncomfortably high.
Market Forces
After little change during the holiday week, financial markets responded bullishly to the jobs report.
Stock prices rose on Friday, and longer-term interest rates moved lower. Traders interpreted the latest news as a sign the Fed’s policy was working to slow the economy and contain inflation. As with many businesses, financial markets anticipate a relatively mild downturn and sharply lower inflation.
We hope this will be the case, but we remain skeptical about a quick end to inflation. Although inflation can decline to the 2 percent vicinity within a year, this can occur only if the Fed continues a restrictive monetary policy.
With oil prices falling by 9 percent in December, expectations are for little or no inflation to be reported in Thursday’s CPI. Even with zero monthly inflation, yearly inflation rates will
remain in the 5 percent to 6 percent vicinity. Any signs that inflation exceeds expectations would be bearish for stocks and bonds.
A sharp decline in wages is unlikely. December’s modest 2.6 percent annualized increase in weekly earnings may have been caused by a shift in the mix of earners. If lower-paid workers make up a larger portion of those sampled, it makes it appear that earnings are rising at a slower pace.
From a technical standpoint, the increase in the S&P500 on Friday brought the index and several others close to their 50-day moving averages. This key resistance level is only the first of many hurdles the index needs to overcome to reverse its negative technical position. For now, the DowJones is the only major index in a positive technical position.
Serious challenges facing both the economy and inflation create potential headwinds for stocks. Hence, we remain cautious over the prospects for a significant near-term recovery in stocks and bonds.
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Outlook
Economic Fundamentals: negative
Stock Valuation: S&P 500 overvalued by 19 percent
Monetary Policy: restrictive