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Changes in U.S. labour market data, such as unemployment, non-farm payrolls, labour market participation, and unemployment among bachelor's degree holders, are closely watched as signals of broader economic health.

Would positive news in this economic data have the positive effect on global stock markets? We need to filter out the short-term noise around these data releases to understand the macroeconomic picture and how it informs investment decisions.

Intuitively, the economic expectation is that a low unemployment rate means strong consumer spending, leading to high corporate earnings, higher stock prices, and greater returns for investors. This is demonstrated in the graph below, which compares the MSCI World total return against U.S. unemployment of bachelor’s graduates.

Sources: Prescient Investment Management, Bloomberg (as at 3 June 2024)

A strong post-Covid recovery has seen a booming labour market and a booming stock market, with the latest data indicating U.S. unemployment returning to a long-term rate of just 3.9% and 2.2% for those with bachelor’s degrees.

If we consider the overall macro picture, low unemployment rates are currently observed at the same time as U.S. interest rates are sitting at 10-year highs and inflation is within the target of 2%. Moreover, the market expects U.S. interest rate cuts in the second half of 2024.

If we unpack labour conditions further, the graph below shows that historically, periods of declining hiring rates are often associated with recessionary periods. Looking at the latest points, hiring rates have remained around their long-term average and even steadily decreased, along with job openings.

Sources: Prescient Investment Management, Bloomberg (as at 21 May 2024)

We have developed the Prescient Economic Indicator, a coincident index that synthesises numerous data categories into a single trend. This indicator offers an ongoing and timely snapshot of economic activity as part of our economics factor, alongside the valuations, financial conditions, and sentiment factors.

The recent data shows that even though unemployment levels are low – indicating good labour market conditions – they are contributing negatively to economic growth.

Given this, does the US Federal Reserve risk cutting rates to drive credit expansion, which will perhaps fuel inflation, or do they leave rates higher for longer to allow the U.S. economy to cool? These are big decisions that have global ramifications.

In these macroeconomic conditions, bad news or negative labour conditions – such as a lower-than-expected number of jobs created or an increased unemployment rate among people with bachelor’s degrees – causes the market to respond positively in anticipation of an earlier rate cut. Conversely, if the data comes in better than expected, the market reacts negatively in anticipation of higher rates for longer.

South Africa’s unemployment levels have significantly increased over the long term, unlike those in the U.S. Overall unemployment is around 32%, and the unemployment rate for graduates is over 10%, up from 5.5% in Q1 2013.

While the South African Reserve Bank (SARB) operates independently, it does not overlook developments in the US when making decisions.  Although the local economy is seeking interest rate relief, a decision to cut rates ahead of the US could negatively impact the Rand-Dollar exchange rate, potentially driving an inflation spike and putting pressure on US dollar-denominated sovereign debt.

Higher inflation and more expensive debt are detrimental to a domestic economy growing at less than 1% per annum. If we thought analysing the US employment market was complicated, understanding the impact on the domestic economy adds a new dimension.

The sentiment remains that we need to see a trend where US labour market conditions worsen and contribute negatively to economic activity. This would put pressure on the Federal Reserve to lower interest rates, which should positively impact the market and potentially benefit investors, as the market has already priced in cuts.

A distinguishing characteristic of the Prescient strategy has been an ongoing investment in our analysis and data teams to help us – and our clients – to analyse these thousands of data points and enhance our decision-making.

Ultimately, investors who can correctly understand macroeconomic trends will enjoy a competitive advantage over their peers. If we are asked whether the unemployment rate of those with bachelor’s degrees in the US can impact your investment performance, our answer is an unequivocal “yes”. DM/BM

Author: Dimpho Sekhaolelo, Quantitative Analyst at Prescient Investment Management

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