Scott Wren
Senior Global Equity Strategist

Key takeaways

  • Stock volatility has increased in recent months due to a combination of factors.
  • Better-than-expected employment data is one of those factors, as accelerated wage growth and a tight labor market spark fears the Federal Reserve (Fed) may misstep. 

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October, overall, was obviously not a fun month for equity investors. A number of the areas of concern for the stock market that we have been talking about for many months came into play and negatively affected the psyche of the market. These concerns included trade frictions, potential Fed monetary policy, and corporate margins, among others. Remember, we are in the last third of this cycle, in our opinion. This is typically when things can get interesting for the stock market. One should always look at underlying economic data and the market relative to where we are in the cycle. For instance, equity investors often take rising interest rates early in a cycle as a positive. But when rates are on the rise late in a cycle, equites frequently stumble. If you can understand how the market will react to certain economic data at specific points in the economic cycle, you will have won at least half the battle. We want to keep hammering home this theme as this particular cycle moves forward.  

The recent employment report covering the month of October is a good example. The number of jobs created last month blew the consensus expectation out of the water. The average economist estimated the U.S. economy would generate 200,000 jobs last month, but the actual number came in at 250,000. And just as important, the year-over-year change in average hourly earnings (compensation) crawled higher to 3.1%. In addition, more people who previously claimed to be on the sidelines decided to jump back into the labor market as the labor participation rate rose a better-than-expected 2/10ths of a percent to 62.9%. Ok, enough with the numbers. The interesting thing about this report, at least in this strategist’s opinion, is how the stock market reacted. The S&P 500 finished lower on the day.  

The October employment report and its relationship to the stock market is a good example of something we have discussed quite frequently. And it is all about where we are in the economic cycle. The stock market, at certain points, will react negatively to economic news that is above expectations and considered too good (or even great). The concept that economic news is too good and then taken as a negative by the stock market may not make sense to many investors. How can a great labor market be considered as anything but a big positive for the stock market?

It all comes down to what effect this better-than-expected economic data might have on the Fed’s monetary policy decisions. Monetary policy that is too tight for a given level of growth discourages borrowing and spending and creates headwinds for a consumption-based economy like ours. Inflation typically increases as the economy accelerates, input costs rise, and the labor market tightens. Recall that one of the Fed’s dual mandates is to strive for price stability.   

Right now, meaningfully better-than-expected labor data will likely not be good for the stock market. Higher labor costs can cut into profit margins. Equity investors can interpret upside employment surprises as giving the Fed a green light to increase the pace and magnitude of rate hikes. Our best advice? Just keep rooting for good, not great, economic data.