For a writer who covers markets, it is always tempting to write calendar-based prediction pieces. After all, we all want to know what is going to happen over the next quarter, half, or year, right? The problem, though, is that such pieces have a major inherent flaw: We cannot know what is coming and, as the past few years of dealing with a pandemic and its aftermath have taught us all too clearly, the biggest influences on markets often come from something completely unexpected and unpredictable.
That said, absent any such “black swan” event, there are some things that could develop into major influences, for good or bad, on the market. It is, therefore, more useful to attempt to identify things that should be watched for changes that may have an impact than it is to try to make any actual predictions. So, with that in mind, what should investors be watching over the next six months?
The obvious starting point is the economy, but your focus on that front should be more on an area where there isn’t currently a problem than on where there is.
There is a lot of talk about whether or not we are headed for a recession in the second half of the year. It is generally held that the cause of that, should it come, will be the Fed’s attempts to control inflation by hiking interest rates and reducing market liquidity. A lot of people will be focused on the numbers that directly reflect inflationary pressures, such as retail and consumer price data, and on GDP growth itself. It is, however, quite possible that the Fed and other central banks around the world will get it right this time, doing just enough to slow growth without pushing us so far as to cause the kind of mass unemployment that we usually associate with recessions.
There is one main reason to think they may be able to do that. The jobs market is so strong going into this that layoffs and hiring freezes can be absorbed for a while without significantly raising the unemployment level. Millions of people leaving the workforce after re-evaluating their work/life balance following covid, combined with years of reduction in immigration that has fueled growth for so long in America, has produced a significant labor shortage.
However, if current conditions persist, that cannot last. The worst effects of inflation are felt by those who live on a fixed income, like retirees. As prices rise, many who chose not to go back to work after covid will be forced to rethink that decision and re-enter the workforce. It is possible that supply of labor will be increasingly rapidly at the same time as demand is falling, and you don’t have to be an economics professor to know what will happen should that occur.
This week, and for the next few months, investors should be monitoring inflation data for sure, but should also be studying the jobs report closely, looking beyond the headline unemployment rate and non-farm payroll numbers. Look instead at the labor participation rate. If that starts to rise significantly, the unemployment rate will quickly drop if employers are forced to cut back at the same time, and that could cause the kind of damaging recession that most of us fear.
There are signs that traders are anticipating something along those lines. The bond market, for example, is currently implying a high in the 10-year of well under 4% in the middle of next year, with rates dropping quickly again after that. That indicates a belief that there will be a problem big enough to force the Fed to reverse course at around that time.
Similarly, commodities, which have been strong as inflation has soared, have turned. The Invesco DN Commodity Index Tracking Fund (DBC), for example, is down 12.3% from its high less than a month ago despite the continued war in Ukraine and seemingly ever tighter sanctions on Russian exports. Again, that is a market move that indicates fear of a “real” recession, one that would seriously harm demand for materials across the board.
If the implied forward 10-Year yield and commodity prices continue to fall early this half, and/or if there are signs in the jobs numbers that the labor shortage is rapidly disappearing, that would be far more indicative of future problems than fluctuations in the inflation rate. If, on the other hand, commodity prices stabilize and job openings continue to outnumber job seekers, it would suggest that the Fed has done just enough to tap the brakes without causing a major crash.
While investors should, of course keep an eye on events in Ukraine and be wary of possible escalation, while also looking out for a deadlier vaccine-resistant covid variant, an increase in tensions between the West and China, or any one of a number of things that could blow up over the next six months, the main focus should be on job numbers and on market indicators of upcoming recession. If those things continue to indicate tough times ahead, we won’t need a black swan event to cause a collapse, but if they turn around, this could all prove to be a storm in a teacup and ultimately, a great buying opportunity.