By Ellen Hazen, CFA®, Chief Market Strategist

February Takeaways:

Stocks weakened modestly during the month:

• • All major domestic indices were down between 1 and 4% during the month of February. They are all still positive year-to-date, though, because January’s returns were so strong. As of February 28, the S&P500 is up by 3.7%
  • International equities once again outperformed US equities: the EAFE index declined by only 2.1%, while the S&P500 declined by 2.5% during the month
• Interest rates increased across the board, with the 2-year Treasury bond increasing by 60 basis points during the month, to 4.8%. The 10-year Treasury likewise increased by over 40 basis points, to 3.9%
• Inflation was higher than expected. The January Consumer Price Index (CPI) reading of 6.4% (released on 2/14/23) was well ahead of expectations of 6.2%. Although 6.4% represents a modest 0.1% decline from the 6.5% we saw in December, this is much smaller than the declines of the prior several months; the average decline since the June 2022 peak has been a 0.4% monthly decline. This higher inflation print will likely lead to a “higher for longer” Federal Funds rate
• 517,000 new jobs in the month of January is an astonishingly high number, compared to the average expectation of 188,000. The unemployment rate dipped to 3.4%, below the average expectation of 3.6%
• Minutes from the February 1-2 Federal Reserve meeting, released February 22, showed that some market participants may be comfortable with increasing the pace of tightening at upcoming meetings
• Earnings were reported for most of the rest of the S&P500 – we saw continued negative operating leverage, with average revenue growth of 5.5% but earnings declines of 3.3%

What We Are Watching in March

• The Federal Reserve will meet again on March 21-22
• New jobs created in February will be announced on March 10
• After the strong CPI report in February, CPI on March 14 will provide additional data on whether inflation continues to abate or if it reaccelerates

The February economic data releases continued to paint a picture of a very strong labor market. Inflation cooled a bit but remained well above the Fed’s 2% target, and cooled less than market participants expected.

The market is currently pricing in one 25-basis-point increase at the March Fed meeting, with an additional 25-basis-point increase at the May meeting. There is, however, a possibility that incoming data may instead cause the Fed to increase by 50 basis points at an upcoming meeting.

As Q4 2022 earnings reporting season wound up, most S&P500 companies continued to show negative operating leverage, where costs grow faster than revenue. Currently, consensus expectations are for that to continue for Q1 and Q2 of 2023, to improve to neutral in Q3, and return to earnings growth outpacing revenue growth in Q4 and beyond. If inflation significantly decelerates from here, this is reasonable; if the recent inflation declines instead stall out and remain above 5%, the Q4 2023 timeline for positive operating leverage may prove to be too optimistic.

We expect continued volatility in both equity and fixed income markets as economic cross-currents paint a mixed picture.

What’s going on with layoffs?

With the decline in technology profits we’ve observed over the past few quarters, the layoff announcements have been mounting. In 2022, companies in the Bureau of Labor Statistics (BLS) “Information” industry laid off a total of 415,000 workers, and this trend has continued into 2023. In just the last two months, Google has laid off 12,000 employees, Salesforce has laid off 8,000, and Dell has laid off 6,000. PayPal, Zoom, Yahoo, Spotify, and other tech companies have laid off workers as well. It’s not just technology: across the economy, layoffs have risen from 2022 levels.

Part of the root cause, as mentioned above, is the profit squeeze we’ve been observing for the last few quarters. Within the technology sector of the S&P500, for example, net margin averaged 24.4% in 2022, down from 26.1% in 2021. When companies are facing cost pressures and the top line is slowing, layoffs are a natural step.

The technology industry also grew headcount enormously over the past few years as tech companies responded to pandemic-driven demand. Google employed 120,000 people just before the pandemic; this had grown to 190,000 as of the December 2022, according to their Sec filing. Laying off 12,000 of the 70,000 hired in the past three years doesn’t seem unreasonable. The 5 largest tech companies increased hiring in aggregate from pre-pandemic levels by 921,000, or by 221,000 excluding Amazon.

How significant is this?

Zooming out, layoffs in the information sector – as defined by the BLS – totaled 48,000 in December. (January figures have not yet been released). This is much smaller than many other industries: the manufacturing industry laid off 101,000 workers, and the construction industry laid off 215,000 workers. And, layoffs were dwarfed by new hires, at 63,000. You can see in the chart below that despite an uptick in layoffs (dark blue) in the later part of 2022, layoffs remain much lower than both voluntary quits (green) and new hires (red). One could argue that many of the smaller company layoffs are a healthy cleaning out of unprofitable business models that were funded with easy money over the past several years.

What this means for investing

Part of the reason we have remained relatively sanguine about the economy is the strong underlying labor picture. Unemployment, at 3.4%, is at a multi-decade low. New jobs have been abundant. The strong labor market has kept the consumer able to spend and has supported GDP. Although layoffs have increased in January and February, we do not currently see the consumer getting markedly weaker, particularly in the near-term.

Layoffs are an unfortunate fixture of the US employment market. This has been true since the 1980s, when companies first started to use mass layoffs as a profit-management tool. One can argue whether this is more or less humane for the employees, and whether it is – over the long term –more or less profitable for the companies. On the positive side, layoffs improve margins and remain low in absolute terms. On the negative side, layoffs are painful for those affected and news reports can shake consumer confidence.

The bottom line

Layoffs are increasing both because tech companies arguably over-hired during the pandemic, and because inflation is causing margin compression, encouraging companies to cut costs. At this point, the absolute numbers do not point toward an employment recession. While layoffs have accelerated in 2023 compared to 2022, the amount of media coverage is in excess of the likely impact on the economy.

Disclosures