Labor market strength has befuddled investors. On the one hand, tight labor markets have made it more difficult for employers to fill positions, which has driven wages higher, exacerbating inflationary conditions and pinching corporate margins. On the other hand, labor market strength has kept hope alive that, while monetary policy is restrictive, growth may slow but not to recessionary levels. This could potentially open the door for a soft landing in which growth slows but does not meaningfully damage the economy. As we explore below, global markets have reflected this optimism through the first half of 2023. 

Market Commentary

The first half of 2023 has seen markets continue a rebound which began late in 2022. The tables below show performance for equities and bonds. At a high level, stocks have enjoyed better than expected economic growth which has translated to positive surprises in profit growth. Growth stocks have been particularly strong, in part due to the optimism for how artificial intelligence (“AI”) may transform the economy. For instance, stocks with a perceived leadership position in AI, such as Nvidia, are up significantly year-to-date, with more on this later as it relates to the S&P 500 Index performance.

Taking a step back, the S&P 500’s strong start to 2023 has been powered by a handful of stocks (listed in the below chart). These stocks account for a majority of the S&P 500’s 16.8% YTD return. Each of these stocks are up far more than the broad index and their large market capitalizations (and their corresponding weighting in the indices) have provided an outsized boost to the broader markets. Compare the performance of these stocks versus the S&P 500 and the average return of the remaining companies, and it is easy see the effect these select group of mega-cap companies have had. 

The bond market has also seen a rebound, as higher yields have offset price declines from the ongoing increase in interest rates. Shorter-term interest rates are currently in excess of 5%, with much of the yield curve sitting near 4% as the market attempts to understand the next move for the Fed.

Labor Markets

For 18 months, the Fed’s focus has been centered on inflation rather than employment, as labor conditions have remained constructive. The chart below highlights why. Inflation surged to multi-decade highs – well above the Fed’s 2% target - while unemployment has remained largely in check. 

The latest CPI data released on July 12 does show the ongoing march back towards Fed targets. The major categories have all begun to come down, albeit at slower pace than initially hoped. The chart below breaks out the components of CPI inflation readings. 

Services, which has been the last component to show declining growth has begun to do so in the last few months, while energy inflation has turned negative. 

While inflation is cooling, the Fed continues to maintain a restrictive policy (i.e., they keep interest rates high to slow the economy to slow inflation) and therefore a shift of focus from inflation to labor may begin. This could be particularly true if the labor market continues to soften. To that end, the softening of the labor market has been a point of contention and the changes, so far, have been subtle:

• Jobless claims have started to rise off the cycle lows (the first graph below), and 
• Job openings are coming down, although they are still quite high by historical standards (the second graph below as shown by the “JOLTs” survey data which is a job opening report by the Bureau of Labor Statistics).

Investors are paying close attention to the labor markets and despite some early signs of softening, the current strength is undeniable. As Chair Powell suggested at the June 14 news conference, slowing growth may be key to bring inflation under control and the labor markets are a critical component. This is a major focus of market participants. While a recession could be in store as a result of the current Fed activity and inflation (amongst other risks), our team is focused on the positive long-term growth prospects underpinning the global economy. The latest economic data has also strengthened the possibility that labor could remain strong enough to help avoid a full recession and enter the soft-landing scenario in which growth cools enough to modify inflation trends, without a recession or at least without a significant recession. As we head through the second half of the year, our team remains ready to adjust to the opportunities that present themselves.

Please reach out to your BDO wealth advisor with any questions or comments.

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Opinions expressed in this commentary may change as conditions warrant and are for informational purposes only. Information contained herein is not intended to be personal investment advice for any specific person for any particular purpose. We utilize information sources that we believe to be reliable but cannot guarantee the accuracy of those sources. Past performance is no guarantee of future performance; investing involves risk and may result in loss of capital. No graph, chart, formula or other device can, in and of itself, be used to determine which securities to buy or sell, or when to buy or sell such securities, or can assist persons in making those decisions. Consider seeking advice from a professional before implementing any investing strategy.

BDO Wealth Advisors, LLC is a Registered Investment Adviser dedicated to providing clients with unbiased, personal financial advice. Working in partnership with our clients, our wealth management team helps organize, enhance, manage, and preserve wealth through sound financial strategies. This information is provided by BDO Wealth Advisors for the personal use of our clients and friends. It should not be construed as personalized investment, tax, or legal advice. Information compiled from Ned Davis Research and additional third-parties. Please be sure to consult your CPA or attorney before taking any actions that may have tax consequences and contact BDO Wealth regarding any investment decisions. Every investment strategy has the potential for profit or loss. 

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