Financial markets have a restored sense of order following recent volatility. The latest data on inflation, retail sales and jobless claims have reassured investors that the economy is moving toward a “soft landing” of slower-but-steady growth and that the Federal Reserve will stay measured in easing monetary policy.
Morgan Stanley’s Global Investment Committee sees this as the most likely scenario, expecting slow and shallow Fed rate cuts to around 3.5% toward the end of next year. However, it’s important to note that this outlook assumes a relatively durable labor market to support consumer spending—and labor-market stability is not assured.
Consumer spending fuels about two-thirds of U.S. economic output, and while the average U.S. household is still spending robustly, consumers are increasingly living paycheck to paycheck. Also, cracks have emerged in the labor market amid declining new job openings and a modest rise in continuing jobless claims. Here’s a closer look at why investors may want to maintain a healthy skepticism about the labor market’s ability to sustain a soft landing.
Signs of Stability
Consider, first, the reasons to be optimistic about the job market, even as cracks may be emerging in some areas:
- Non-farm payrolls—which tracks the number of jobs that U.S. private employers have added in a given month—did disappoint in July, but the three-, six- and 12-month averages remain solid.
- The unemployment rate ticked up recently, but that was actually due to growth in the labor force itself, which is a positive sign, and higher rates of participation, also positive, rather than to a lower number of available jobs.
- Although the number of new job openings has declined, hiring rates remain steady, and layoffs and firings are benign.
- Most importantly, optimism among small businesses—where most jobs are created—has begun to rebound along with companies’ hiring plans, ignited by excitement about Fed rate cuts and the upcoming release of $80 billion in employee-retention tax credits from the federal government.
Data points like these suggest a growing, not receding, economy.
Cause for Caution?
That said, the delicate balance for labor markets—and, thus, consumer spending and the prospect of a soft landing—may hinge on corporate actions.
Wall Street analysts’ current profit estimates appear ambitious, calling for accelerating and double-digit growth rates over the next six quarters, even as margins are already near record highs. Yet nominal growth in gross domestic product is likely to slow and companies’ pricing power could wane, likely weighing on profitability. The gains that companies have enjoyed from falling costs and the advantages of a strong U.S. dollar may also fade.
Under those circumstances, companies’ ability to deliver on their profitability estimates would likely hinge on either increasing productivity or cutting labor. In the latter case, if job losses rise significantly, it could put the soft landing at risk.
Investment Implications
On that cautionary note, consider owning quality U.S. equities that can provide growth at a reasonable price, alongside investment grade credit. We continue to find compelling ideas in financials, industrials, energy and materials, as well as infrastructure-linked stocks.
We also like pockets of technology, such as software, as well as healthcare and more-defensive stocks in residential real estate investment trusts (REITs) and utilities.
This article is based on Lisa Shalett’s Global Investment Committee Weekly report from August 19, 2024, “Labor Market Now in the Crosshairs.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.
