Stock market in a ‘very dangerous’ position as jobs and wages run hot, fund manager says

Key Points

• Concerns about U.S. Stock Market:
  • The U.S. stock market is viewed as being in a precarious situation, with persistently strong jobs numbers and wage growth challenging the effectiveness of Federal Reserve interest rate hikes, according to Cole Smead, CEO of Smead Capital Management.
• Strong Economic Indicators:
  • January’s nonfarm payrolls grew by 353,000, exceeding Dow Jones estimates of 185,000, and average hourly earnings increased by 0.6%, double the consensus forecast. Despite these strong indicators, Fed Chair Jerome Powell indicated that the central bank would likely not cut rates in March, contrary to market expectations.
• Risk Factors and Potential Market Trends:
  • Cole Smead contends that the real risk lies in the unexpected strength of the economy despite significant interest rate hikes. He questions whether the Fed’s policy tools have effectively caused the lowering of the Consumer Price Index (CPI) and highlights the continued strength of wage growth, indicating potential inflationary pressures. Smead suggests that the fall in CPI should be attributed to “good luck” from factors outside the central bank’s control. If economic strength persists, the Fed may need to keep interest rates higher for longer, potentially leading to challenges for listed companies refinancing at higher levels and a lack of benefit for the stock market from economic strength. Smead draws parallels to a historical period (1964-1981) where a strong economy did not proportionately benefit the stock market due to inflationary pressures and tight monetary conditions, suggesting a similar trend may be emerging.
• Contrasting Views on Monetary Policy:
  • While Smead expresses concern about the stock market being priced with economic strength and the Fed constrained into maintaining high rates, some strategists argue that the recent strong economic data indicates the Fed’s successful efforts to engineer a “soft landing” for the economy, limiting the downside for the broader market. Investors are becoming more comfortable with central banks balancing growth and inflation, creating a relatively constructive backdrop for stocks in the current benign macro environment. Richard Flynn of Charles Schwab U.K. notes that recent strong jobs data, which previously might have set alarm bells ringing, now seems to be well-received by investors, suggesting a potential delay in the Fed’s first rate cut closer to summer if the economy maintains its comfortable trajectory. Daniel Casali from Evelyn Partners echoes this sentiment, stating that investors are becoming more comfortable with central banks managing the delicate balance between growth and inflation, creating a constructive environment for stocks.