Ep 6: Stock Market Update | The Fed, Inflation, and the Labor Market

Navigating the Stock Market Amidst Inflation and Labor Market Imbalance

Welcome to our July 2023 Stock Market Update! As Albert Einstein once wisely said, "If I had an hour to solve a problem, I'd spend 55 minutes thinking about the problem and 5 minutes thinking about solutions." With that in mind, let's take the time to understand the challenges our market is currently facing before we explore potential solutions. One crucial aspect to consider is the role of Monetary Policy, implemented by the Federal Reserve (commonly known as the Fed) and led by Mr. Jerome Powell.

Before we dive deeper, let's define a few key terms to ensure we're all on the same page:

• Inflation: Measured by the Consumer Price Index (CPI), inflation refers to the situation where there are too many dollars chasing too few goods and services, leading to significantly higher costs.
• The Fed: Short for the Federal Reserve, it plays a vital role in shaping the nation's monetary policy and maintaining economic stability.
• Monetary Policy: This encompasses the tools and actions employed by the Fed to regulate the money supply, interest rates, and overall economic conditions.

Identifying the Problem:

Now, one of the primary sources of the problem we're facing is the imbalance in the labor market. You might have heard it referred to as the labor market being out of balance, hot, or cooling. Essentially, this means there are more job openings than available workers. Just as the Fed has its eye on the labor market, so should we. The Fed aims for a trend of labor market cooling. But what does that mean exactly?

To measure this, we look at the labor market participation rate, which reflects the percentage of people actively participating in the labor force. Pre-pandemic, this rate stood at 63%, and we've currently returned to that level. Additionally, we want to see job openings "cooling" as well, indicating a slowdown. While job openings in the goods sector are indeed slowing down, growth is occurring in the services sector. To simplify, goods refer to tangible items like phones, clothes, and cars, while services encompass activities like travel, dining out, and hotel stays—those non-tangible experiences. Another important metric to watch is the unemployment rate. Unfortunately, an increase at a moderate pace indicates more people actively seeking employment, thus helping balance the labor supply. All these measures collectively provide insights into whether there are fewer job openings and more people looking for work, pointing towards a "cooling" trend.

The Fed's tools tackle demand and we have a supply issue. Specifically, a labor supply issue. There are too many job openings and not enough people to fill those jobs and the Fed cannot print people. The only solution is immigration or automation.

The Fed's Role:

Now, let's explore the role of the Fed in addressing this issue. While they can't "print people," they do have the power to implement policy measures that contribute to the solution. As another Einstein quote reminds us, "We cannot solve our problems with the same thinking we used when we created them." The Fed, too, played a part in creating the problem, which merits a separate episode to fully explain.

Tools of the Fed:

• Quantitative Tightening (QT) and Quantitative Easing (QE): These are policy measures employed by the Fed to control the money supply and stabilize the economy. Right now the Fed is in QT mode, which means as their investments mature, they allow them to mature and do not repurchase new ones.
• Fed Funds Rate: This is the interest rate at which banks lend to each other overnight. Adjustments to this rate can influence borrowing costs and economic activity.
• Word of Mouth: Communication from the Fed, particularly from its Chairman, Jerome Powell, can have significant impacts on the market and investor sentiment.

Delving Deeper into Labor Market Participation:

Given Einstein's wisdom, let's continue focusing on understanding the problem, as we've only scratched the surface. I delved deeper into the labor market participation rate, and while it has returned to pre-pandemic levels of 63%, this isn't the case for all age groups. The 16-24 and prime-age groups make up the working labor force, but those aged 50 and above have opted for retirement rather than returning to work. Cruise stocks are soaring, which aligns with this trend. These retirees contribute to the inflation in the services sector. This vulnerability is worth noting because the Fed desires continued cooling of the labor market. However, if retired individuals are less likely to reenter the workforce, we may have hit a roadblock. The only viable solution I see for increasing the labor force is through fiscal policy, such as increased immigration to augment America's labor supply. With a divided government at present, significant changes may not be forthcoming.

Seeking Solutions: The Role of Automation:

Returning to the core problem of labor market imbalance, what if we could achieve the same level of output with fewer workers or outsource certain tasks? This is where the potential of automation comes into play. If you were thinking of artificial intelligence (AI), kudos to you! One of the highlights of this episode was Jessie's insight that automation can solve this problem. Brilliant! The Fed is fortunate to benefit from AI enhancements that have created a global tidal wave. Countless AI-driven advancements, including chat GPT, Adobe Firefly, Anthropic, Claude, Bard, and many more, increase productivity and offer creative solutions to the labor supply issue. Enhancing productivity serves as a headwind-turned-tailwind, leveraging the labor market's challenges to propel AI-driven advancements.

Impact on the Stock Market:

Now, you might wonder how all of this impacts the stock market. Powell, among other factors, considers this data to shape monetary policy. Labor market data, including the monthly employment report and other employment indicators, can significantly influence market movements. Generally, a more restrictive stance from the Fed indicates a downward market trend. We witnessed the market bottoming out in October when the Fed halted its pace of tightening money. As indications of smaller interest rate increases emerged, the market trended higher. Ultimately, everything revolves around the consumer: When the Fed raises rates, access to money becomes more challenging, resulting in decreased demand for goods and services and lower costs. Your credit card rates go up, making you less likely to borrow, which further drives prices down.

The Earnings Perspective:

The crucial question is: How does all of this translate to earnings? Less consumer spending equals lower revenue, while decreased labor costs translate to reduced expenses. It's essential to examine where people are spending their money and identify companies with efficient operating expenses, ultimately leading to better profit margins. Earnings season kicks off heavily during the third week of July, so stay tuned for our August market update to see how all these dynamics play out.

In conclusion, we've taken a deep dive into the complexities of inflation and labor market imbalances, both of which have significant implications for the stock market. By delving into the problem, we gain a better understanding of the factors at play. Remember, understanding the challenges is key to navigating the ever-evolving market landscape. Keep a keen eye on the labor market data, the Fed's actions, and the impact on monetary policy. With this knowledge, you can make informed investment decisions and adapt to changing market conditions. Stay tuned for future updates and embrace the exciting opportunities that lie ahead in the world of equity investing!

• Q: What is the big theme of the overall market as of July 1st, 2023?
• A: The big theme is inflation, and the FED is actively trying to battle inflation by slowing down the economy.
• Q: What is the FED, and what is its main function?
• A: The FED refers to the Federal Reserve, and its main functions are price stability and employment. It sets monetary policy, including interest rates, and aims to achieve low unemployment levels.
• Q: How does the FED control interest rates, and how does it affect the stock market?
• A: The FED controls interest rates by setting the FED funds rate, which is the rate at which banks borrow from each other. Raising interest rates makes it more expensive for consumers to borrow money, which can reduce spending and impact the stock market.
• Q: What is the difference between a bullish market and a bear market?
• A: A bullish market means the stock market is going up by at least 20% from its low point, while a bear market indicates a decline of 20% or more from its peak.
• Q: How does the labor market affect the stock market?
• A: The labor market is a significant factor in the stock market. If there are supply issues, such as a shortage of labor, it can lead to inflation and impact the stock market. Productivity improvements, automation, and immigration can help address labor supply issues.
• Q: How do layoffs in the tech sector affect stock prices?
• A: Layoffs in the tech sector can sometimes lead to higher stock prices for those companies. When tech companies announce layoffs, it can signal cost-cutting and increased efficiency, which can positively impact their profitability and stock performance.
• Q: Is it too late to invest in tech companies focused on AI?
• A: It is not necessarily too late to invest in tech companies focused on AI. However, it is important to analyze stocks and have a well-defined investment thesis before making investment decisions.