The following commentary was originally sent to Action Alerts PLUS subscribers on March 1, 2016, at 1:35 p.m. ET.
The U.S. economy added 242,00 jobs in February, well above expectations for 200,000, with the enthusiasm somewhat contained by weaker-than-expected wage growth. While the quality of the headline number is up for debate, there is no question that the report set a new market consensus around the timing of the Fed's rate hike: Fed fund futures markets are pricing a near 70% probability of a rate hike this year, versus 55% probability earlier in the week. One month ago to the day, the odds were below 4%.
In our view, while the report sends a mixed single (remarkable job creation tempered by disappointing wage growth), it is a largely positive signal for the U.S. economy --and at the very least should lay to rest fears around a looming domestic recession or potential for negative interest rates.
We view the report as a positive for:
- Our financial names -- Bank of America (BAC:NYSE) and Wells Fargo (WFC:NYSE), given heightened expectations around a 2016 rate hike;
- Our domestic retail names -- including Jack-in-the-Box (JACK:NYSE), Panera (PNRA:Nasdaq), Target (TGT:NYSE), and WhiteWave (WWAV:NYSE); and
- AAP holding Stanley Black & Decker (SWK:NYSE), given its cyclical economic exposure and leverage to the housing market.
On the other hand, we view the jobs report as a slight negative for:
1. Our high dividend holdings -- including American Electric Power (AEP:NYSE), Cisco Systems (CSCO:Nasaq), Dow Chemical (DOW:NYSE), Kraft Heinz (KHC:Nasdaq), Eli Lilly (LLY:Nasdaq), and Lockheed Martin (LMT:NYSE), as higher rates means that dividend yields are relatively less attractive.
Separately, we expect the report will provoke dissent and deepen dividing lines within the Fed's Open Market Committee, pitting the more-hawkish presidents (including Kansas City's Esther George, Richmond's Jeffrey Lacker and San Francisco's John Williams) against the more-dovish presidents (including Boston's Eric Rosengren, Dallas' Robert Kaplan, and Philadelphia's Patrick Harker).
The hawkish camp will argue that the strong job growth and upward revisions belie the uncertainty abroad, while the dovish camp will argue that the deceleration in wage growth disguises the headline strength and suggests inflation remains pressured.
Beyond the headline beat and 4.9% unemployment rate, the biggest positive takeaways for the report include:
- Upward revisions in both January (to 172,000 from 151,000) and December (to 271,000 from 262,000 in December) numbers;
- Higher participation rate, which ticked up a full half point to 62.9% in February, above expectations and the highest level in over a year;
- U6 unemployment rate -- which includes workers who are part-time for economic reasons -- fell to 9.7% from 9.9%. Strong gains were seen in health care, retail and restaurants.
On the negative side, average hourly earnings fell 0.1% month-over-month and rose 2.2% year-over-year, both below consensus forecasts for a 0.2% increase from January and 2.5% over the prior year. We would also note that job growth was not broad-based, as manufacturing and mining jobs fell more than expected, suggesting that we have yet to see a bottom in the industrial slowdown.
All in, the biggest takeaway is simple: jobs are strong, wages are weak. The former outweighs the latter, at least in magnitude, which puts a June rate hike back on the table and defies the notion that the U.S. economy is directly tethered to the volatility, uncertainty and structural weakness abroad.
We are not off the hook, however, and we would caution subscribers to balance the headline enthusiasm against the recognition that our markets are still quite sensitive to what is going on abroad, and that a premature Fed rate hike (see: December 2015) is nothing to scoff at, even in the face of encouraging data. The markets are an ever-expanding puzzle, and while the latest data help fill in a portion of the pastiche, plenty of missing pieces remain, only to be discovered with time.