EDITOR'S NOTE: The stock market has had a challenging year riding on optimism-fueled rallies only to be mauled by bearish economic data. Leading up to the latest jobs report, the market was almost certain the economy was out of the woods, so to speak. That ended when jobs growth exceeded the Goldilocks level, spewing figures that came in too hot. Wage inflation, once again, reared its ugly head, singing an ominous tone of the Fed’s tightening rack. Bank of America sees another vicious twist to this narrative. It sees the cold side of the Goldilocks barometer for the labor market: a massive loss in jobs in the first quarter of 2023, enough to crater the economy.
The latest jobs report shows that the U.S. labor market is in decent shape, but Bank of America sees trouble looming in the distance.
In October, total nonfarm payroll employment rose by 261,000, beating economists’ expectation of a 200,000 increase. It also means that America’s job growth is heading in the right direction.
Bank of America, however, expects nonfarm payroll gains to be cut in half in Q4 of 2022 and turn negative in 2023. During the first quarter of 2023, the bank projects that the U.S. will be losing roughly 175,000 jobs a month.
And it’s not just the labor market that’s going to take a hit.
“We are looking for a recession to begin in the first half of next year,” Bank of America’s head of U.S. economics Michael Gapen told CNN.
“The premise is a harder landing rather than a softer one.”
Let’s take a look behind the bearishness.
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Inflation, unemployment, and the Fed
The U.S. Federal Reserve has a dual mandate: to ensure price stability and aim for maximum employment.
The first task has been a challenge: prices have been anything but stable. In June, U.S. consumer price index saw its biggest 12-month increase in 40 years. While the headline CPI number has cooled off from its peak recently — September’s inflation rate was 8.2% year-over-year — it’s still worryingly high.
The labor market — the Fed’s second task — seems to be in much better shape. In September, the unemployment rate fell to 3.5%, a multidecade low.
Given this labor market strength and rampant inflation, the Fed is raising interest rates aggressively to bring price levels under control. The central bank increased its benchmark interest rates by 75 basis points last month, marking the third such hike in a row.
Gapen expects the Fed to remain hawkish.
“They’ll accept some weakness in labor markets in order to bring inflation down,” he says, adding that “we could see six months of weakness in the labor market.”
According to the Fed’s latest projection, Federal Open Market Committee participants have a median forecast of 4.4% for the unemployment rate in 2023.
Gapen, on the other hand, sees the unemployment rate in the country rise to 5% or 5.5% next year.
More downside for stocks?
The prospect of negative job growth and a recession probably won’t bode well for the stock market. When the economy contracts, corporate profits usually deteriorate.
In fact, stocks have already been pummeled — the S&P 500 has plunged 25% year to date.
Bank of America’s head of U.S. equity and quantitative strategy Savita Subramanian recently said that the benchmark index is “expensive” and “super crowded.”
“The worst thing to hold is the S&P 500 wholesale,” she tells CNBC.
Subramanian suggests that if you have a 10-year investment horizon, you can “hold the S&P 500 and watch and wait.”
“But if you're thinking about what's going to happen between now and let's say the next 12 months, I don't think the bottom is in.”
What should investors do?
Subramanian sees opportunities in small-cap stocks, energy, and healthcare. She also likes “select industrials” — particularly automation plays.
Originally published on Yahoo Finance.