May jobs report: Payrolls increase by 339,000

What slowdown? May payrolls defied expectations, coming in at 339,000, much higher than the expected 195,000. But dig a little deeper, the headline numbers may not tell the whole story. Greg Daco, Chief Economist at EY and Emily Roland, Co-Chief Investment Strategist at John Hancock Investment Management break down the report for Yahoo Finance Live.

Video Transcript

- For more on this jobs data we're joined by Greg Daco, who is the EY, Chief economist and Emily Rowland, John Hancock Investment Management, Co-chief Investment Strategist. Great to have you both here with us on this morning. Happy jobs day to you both, who I believe celebrate as well. So, Greg, you're here in studio. Let's begin with you. I was kind of looking at your facial reactions as this number came out, much larger than expected on the headline print.

GREG DACO: Much larger than expected when it comes to the headline jobs print. But I think we have to dig a little bit deeper into this report and look at some of the underlying indicators. On the jobs front, there was still fairly low diffusion of job growth. 60% of private sector occupations saw job growth. That's on the lower end.

Hours worked fell back to 0.3%. That's below pre-pandemic levels now. Those are type of indicators that we have to pay attention to. The breadth and diffusion of the job market is as important as the headline print.

We also saw that the unemployment rate rose. And if you look at the household survey, there was a massive drop, 300,000. 310,000 jobs lost on the household survey front. And an increase of over $400,000 in the number of unemployed. These are also important data points that we have to keep in mind when we're looking at the breadth of the job--

- So what do they tell us?

GREG DACO: They tell us that we have to be careful not to assume that this 300-plus thousand jobs headline print is as strong as it would otherwise indicate. That means, that for the Fed that is looking at these numbers with a lot of care and a lot of attention, they have to really look at the broad set of numbers, not just focus on one headline print, which is indeed very strong and shows robustness in the labor market. But there are some cracks starting to appear in the foundation.

- And Emily, does that help then maybe explain why there doesn't seem to be that clear reaction in the market that says, the Fed is going to go again?-I mean, for example, I'm looking at the Fed watch tool from the CME. And it hasn't budged that much. Most participants are still looking for a pause at the June meeting.

EMILY ROWLAND: Yeah, Julie, I've been refreshing the CME tool myself here and seeing the same thing. And it might be to what Greg is speaking of. And I want to say, real quick shout-out to Greg.

The only disappointment I have being on the show with him today is I can't be on his Twitter feed getting analysis on the jobs report. So thank you Greg so much for that. Your data is awesome.

But, yeah, very muted response from the market. One thing that I'm watching is the two-year Treasury yield. Here just kind of yawning a little bit. We're just seeing that up about three basis points-- future is sort of holding in steady with some gains here.

So it seems like maybe-- it feels a little bit Goldilocks in terms of the reaction here. Of course, wage growth moderating a bit, I think is a positive here in terms of the trajectory of inflation. And some of the data over the past week has suggested that the labor market is tightening.

Most importantly, the Q1 productivity report showed that unit labor costs were revised heavily down from about 5.8% to 3.8%. That is a data point that economists watch really, really closely.

We also saw the quit rate returning to 2019 levels. That basically is suggesting-- we had a pocket there, where a lot of people felt comfortable leaving their jobs. And confident that they could make more money elsewhere. We're moving past that period of the great resignation in the US. So I think, there's been a cacophony of data over the past week that does suggest that the labor market is slowly starting to show some cracks here.

- How does that show up in the number of consumers out there right now that are looking at the employment situation? Because we heard from the Conference Board that consumers that are looking at their ability to perhaps move from one job to another, get a job, or an increase, a salary bump as well, that factors into how they spend. And so, how should consumers look at this employment situation?

GREG DACO: Well, I think it's a story of nuance. I think we have to understand that we are not in a period of retrenchment. We're in a period where we are starting to see some signs of a slowing in the labor market. And that is the key backbone to consumer spending activity. Both job growth and wage growth combined for income growth.

And what we're seeing on that front is a softening of the trend. Nothing dramatic. Nothing to panic about but that slowdown in the trend on the income front is concerning because we still have elevated inflation. And importantly for consumers, elevated prices.

That means they're buying power is reduced. And they're increasingly going to push back against these prices. That's what we're starting to see in terms of consumer spending trends. And the fundamentals in terms of households, in terms of their credit situation, and their finances. It's also slowly deteriorating.

We're seeing higher delinquencies. We're seeing higher debt servicing costs. And we're seeing an environment where excess savings are no longer that buffer that allow consumers to withstand any type of shock.

- So Emily, what does all this mean for recession outlook, and therefore investment outlook?

GREG DACO: You know, it's just a slow-moving, late-cycle environment as Greg alluded to. You have this lag impact of Fed tightening that is yet to impact the labor market. And you also see the services side of the economy booming. We also got PMI data earlier this week, which again, suggested that manufacturing is very-- very well be in a recession. But the services side of the economy the consumer is still spending. Because of course, everybody still got a job.

So we see us in this late-cycle environment, which can be really tricky. The data are bouncing around all over the place. Again, we're seeing very different reads on the economy. We do think that this likely unfolds into a recession.

We do think that the lagged impact of Fed tightening-- especially, such a large amount of tightening in a short amount of time, does eventually put pressure on corporate margins. And as companies deal with those margins and start to defend them, their biggest cost-cutting is probably going to come on the labor side. So we do eventually see that playing out here.

But of course, we've got to be patient. We still want to have some offense as we're not there yet. But we want to be really mindful in portfolios in starting to sort of prepare for that environment. Get a little bit more offensive, load up on higher-quality stocks, and embrace bonds.

- What does offense look like in a portfolio?

EMILY ROWLAND: Well, it means continuing to have some equities. Right now, we're favoring the US over international equities. It's simply where you're going to find higher-quality companies. These are ones with great balance sheets, good return on equity, lots of cash, a limited need to have the issue equity or debt in an environment where the cost of capital is going up.

Frankly, the poster child for quality is us technology stocks, large-cap growth stocks. And clearly, we've seen those catch a bid. We want to be mindful of the valuations there. Given the run that we've seen in tech, it's responsible for about 80% of the market's returns.

So far here in 2023, so we want to look to other areas. We have classically defensive sectors in our portfolio like utilities, where we're seeing utilities actually trading at a discount to the broad market. We haven't seen that in a long time. So we're emphasizing that in portfolios.

And then, some value in order to minimize our exposure to unprofitable, growth at any price, zombie companies that have binged on 0% interest rates over the past couple of years. So it's really that combination of higher quality and more defensive equities and portfolios to get us through this.

- Greg, as we talk about the different areas that people are looking to put their money. I'm struck also by this different-- I know you look very macro but there's also sort of the corporate inputs into your models. I would imagine. And in so confusing to me right now.

Because on the one hand, you have some retailers saying that consumers are trading down or they're not buying discretionary items. Then you have Lululemon, which is doing great. Especially, in China but even in the US. And you have Nvidia saying that companies are spending money on AI chips. So what like the message is just so murky right now.

GREG DACO: It's extremely difficult to decipher the US economy today. We talked to a lot of customers across a broad range of sectors at EY. And what we're hearing is a couple of things. First, we're hearing bifurcation when it comes to consumer spending trends.

We're hearing that some individuals still have the means and the ability to spend, despite high prices and despite this evidence of a bit of a slowdown in the labor market. We're seeing more difficulties at the lower end of the consumer spectrum.

We're also hearing from companies that if they have the means to do so, they're thinking this is the right time to invest. So this is not the typical type of recession. And pulling out the '09, '08, '09 or even the COVID recession playbook is not going to work in this environment. You have to understand the unique features of this labor market.

As Emily was highlighting, we have an environment where talent is extremely valuable. So you're not seeing the type of rapid retrenchment, massive layoffs across the board. You're seeing strategic hiring freeze decisions. You're seeing strategic layoffs instead. That makes it very difficult to decipher if you're looking at the old playbook when it comes to assessing the strength of the economy. And that's where the nuance comes in.

- Some of the sectors that were the strongest professional business services in terms of adding jobs at least. Professional business services, government health care, still, leisure and hospitality trending higher. But zeroing in on some of the weaker areas-- manufacturing, wholesale trade, retail trade, kind of pulling through some of what we had heard from the ISM data that came out even yesterday.

And where the backlog of orders is sitting at a level that we haven't seen since the Great Recession. They noted within that report. So what does that mean, for how long some of these sectors can continue to be challenged, especially, on the employment situation front, given that they're not sure when that demand is going to re-ensue?

GREG DACO: I'll come back to a point that you made earlier about confidence. A lot of the soft data readings, the confidence readings are fairly weak, and in line with recessionary levels. If you look at some of the hard data. They're not showing that type of recessionary plunge in economic activity.

I think that's really what you have to focus on. What are businesses doing? Are they retrenching or are they investing at a slower pace, spending at a slower pace? And I think the latter is really the true picture of the economy that we're seeing today. That means, it's that much more difficult for the Fed to explore this environment and know how to react.

Excessive data dependence and data point dependence as we've seen from a few policymakers is very risky. We know that the status quo is essentially a pause or perhaps a skip at the June meeting. But there's going to be a lot of focus still on this backward-looking data. We have a CPI report next week. That will get a lot of attention.

And with this headline print, I'm sure there's going to be a lot of chatter about the Fed. Potentially, still thinking about raising rates in June. Even though, I don't think that's what they're going to do.

- And Emily, just to go back for one second to something else you were talking about or that you have talked to us a lot about. And that's the Treasury market. Is it time for people to lighten up on their Treasury holdings at all?

EMILY ROWLAND: No. We would actually suggest the opposite. We think that there's a very attractive entry point right now for leading into duration. We've seen obviously, a massive backup in bond yields as a result of higher inflation and more aggressive Fed.

And we think some of those things that have really been painful for bond investors is actually-- go from being your worst enemy to being your best friend. Maybe we see the Fed hike one more time. Right now, the bond market is pricing in a pause in June, then a hike in July. But then, cuts in September and December.

So the bond market is telling you that the Fed is about to make a mistake, essentially. And what we do see going into recessions of course, historically, is that the Fed cuts rates. And we see a pretty precipitous decline in 10-year Treasury yields. So we think that duration starts to be a tailwind heading into the recession.

And then, on top of it, you're getting income, which is something that bonds haven't had in a really long time. So we're looking opportunistically at this. We think being short duration is not ideal at this stage of the game. We understand that it's very attractive looking at shorter-term paper in terms of the yields but there's significant reinvestment risk there as yields come down. So we think moving out the curve, really sort of emphasizing intermediate-term bonds here is the way to go for the rest of this year.

- Good stuff from both of you. Thank you so much. It's always great to see you Greg Daco in the studio. EY Chief Economist and Emily Rowland, John Hancock Investment Management, Co-chief Investment Strategist.

As you said, you can go back to Twitter now and take a look at Greg's. Is the tweeting coming from inside, Greg? Have you been tweeting while you've been on set with us?

GREG DACO: Not yet. Not yet. But I will do.

- So I've been focused. All right, thanks guys. Appreciate it.