Tight jobs data puts a spanner in investors’ works but an as-expected CPI figure may help

If investors need reassurance after stronger-than-expected labour market data raised expectations of more interest rate rises, then Wednesday’s CPI figures might help.

Markets seem to be worrying that disinflation is too good to be true. Picture: AAP

As much as lower-than-expected inflation data has helped global sharemarkets this month, investors looked to be in need of reassurance after stronger-than-expected labour market data lifted bond yields and raised expectations of more interest rate rises in Australia and the US.

Next Wednesday’s release of Australian CPI data may give that reassurance if it’s no higher than expected, but markets also face an FOMC meeting at which another US rate increase is expected and Fed chairman Jerome Powell is expected to remain wary despite rapid disinflation so far.

The S&P 500 fell on Thursday as US initial jobless claims surprisingly fell.

But the US benchmark has gone a remarkable 40 days without a fall of at least 1 per cent.

The CBOE VIX volatility index rose to 13.99 per cent after hitting a 3½-year low of 12.73 per cent last month. But volatility is very low considering the risk of recession was still around 65 per cent after aggressive interest rate rises, according to Bloomberg’s survey of economists.

The Dow Jones Industrial ­Average rose for a ninth day running as Johnson & Johnson surged on a strong earnings report and US banks continued to rally after mostly better than expected reports.

There was also a minor fall in the US tech sector as outlooks from Tesla and Netflix disappointed lofty market expectations, causing a sell-off in a range of high-flying mega-cap tech stocks that pushed the Nasdaq down 2.1 per cent – its biggest daily fall in almost five months – from a 15-month high.

In Australia, the S&P/ASX 200 hit a three-month high of 7383.3 points on Thursday before stronger-than-expected domestic jobs and US initial jobless claims data rekindled interest rate concerns.

The market-implied chance of the RBA lifting rates by 25 basis points next month more than doubled to about 60 per cent, and futures implied a peak cash rate of 4.51 per cent in February.

In the past week, markets seem to have gone from joy over “immaculate disinflation” in the US and Australia to worrying if it might be too good to be true while labour markets remain so tight.

Meanwhile, second-quarter US earnings reports are mostly beating expectations.

Only 16 per cent of S&P 500 companies have reported so far, but 77 per cent have beaten expectations, with an average beat of 11 per cent. Consensus expectations of a 7 per cent fall in earnings in the year to the June quarter are likely to be beaten by a wide margin, according to AMP.

But Capital Economics says it’s easy to lose sight of the big picture in regard to recession risk.

Not only has the peak-to-trough drawdown in earnings per share from last year been smaller than usually seen in an economic downturn, the consensus estimates are starting to rebound.

The implication is that investors aren’t braced for even a mild recession.

Admittedly, the scale of drawdowns in S&P 500 reported operating trailing 12-month EPS around downturns has varied considerably over the decades.

But even after stripping out the unusually large plunge in EPS during the Global Financial Crisis, the average drop in EPS during US recessions since 1960 has been about 18 per cent, compared to only about 6 per cent this time around, according to Capital Economics.

That isn’t as large after accounting for higher-than-average inflation recently, but in real terms, the peak-to-trough decline since last year is still only about 12 per cent, compared to a post-1960 average decline of 22 per cent, ­excluding the decline around the GFC.

What’s more, expectations for operating trailing 12-month EPS started to pick up in the first quarter of this year, and are projected by analysts to continue to rise until the end of next year, in both nominal and real terms, assuming a gradual return to 2 per cent ­inflation.

“That can’t all be pinned on optimism about a few sectors of the stockmarket,” Capital Economics chief markets economist John Higgins says.

“Although next 12-month EPS has picked up sharply for a big-tech-heavy ‘supersector’ – comprising consumer discretionary, information technology and communication services – they dropped substantially last year and accounted for much of the drawdown in EPS for the market.

“Meanwhile, there is little sign of next 12-month EPS in other sectors – excluding energy, whose earnings can be volatile – coming under the sort of pressure that might be expected during a recession.”

However, Higgins notes that renewed optimism about earnings only goes a small way ­towards explaining the impressive turnaround in the stockmarket so far this year.

“That’s been driven much more by a surge in its valuation, which has been concentrated among a handful of mega-cap firms in the supersector identified earlier amid enthusiasm about their ability to benefit from the transformative technology of Artificial Intelligence,” he says.

His expectation that a mild economic downturn in the US lies around the corner leads him to forecast that the stockmarket will pull back in the second half of the year.