By Anna Rathburn, Chief Investment Officer, CBIZ Investment Advisory Services
The description of the American economy has suddenly shifted from “resilient” to “softening” during the second quarter of 2024. Leading the sentiment has been weaker data from labor market reports, disappointing retail sales and increasing delinquencies in consumer credit. But sometimes bad news is good news in the marketplace. Softer economic data has been linked to the higher probability of rate cuts by the Fed, and that is good news for investors and dealmakers.
The Jobs Market Surprise
During the second quarter, cracks began to surface in the U.S. labor market. The headline unemployment rate moved incrementally from 3.8% in March to 4.1% in June. Underneath the surface, the headline job gains of 206,000 in June were mostly from noncyclical areas of the economy: government, health care and social assistance. Supporting the pressures in the employment situation, we saw job openings fall to levels not seen since the first quarter of 2021.
Inflation Settles and the Fed Shifts its Focus
The June Consumer Price Index (CPI) came in below all consensus estimates, with the headline CPI settling at 3.0% YoY, the lowest since March 2021. As the inflation profile closes in on the Fed’s 2% inflation target, the central bank is shifting its focus away from prices to the labor market. In the context of softer jobs market data recently, the Fed funds futures market is pricing in a first 25-bp rate cut in September 2024.
AI-Related Frenzy or a Flight to Quality?
The S&P 500 Index continued to hit record highs during Q2 2024, driven by the Magnificent Seven stocks[1]. While investors attribute the rise of a handful of tech stocks to artificial intelligence, there may be another explanation. These tech names are flush with cash, have little debt and have accounted for more than 50% of the YoY earnings growth of the S&P 500 Index in Q1 2024. In other words, these stocks are “quality” names. As the economy shows signs of softening, investors may be accomplishing two things at once: participating in the AI upside and allocating to quality balance sheets.
The Cost of Capital
The historically tight corporate credit spreads started to unwind during Q2 2024 — investment grade option-adjusted corporate spreads (OAS) widened by 4 bps and high yield OAS by 10 bps. Such widening may seem counterintuitive as the S&P 500 Index hit new highs, but excluding the Magnificent Seven stocks, the public markets have been struggling: small cap stocks were down 3.3% for the second quarter as represented by the Russell 2000 Index. The Fed’s start of the rate-cutting cycle will be important to credit investors who pay attention to the cash flow and interest coverage profiles of companies.
Is a Soft Landing Possible for the U.S. Economy?
The probability of this achievement increases the earlier the Fed starts its cutting cycle. Currently[2], two rate cuts are priced into the market for 2024, and the CBIZ house view is that we will most likely get them. We also think that the Fed should start cutting rates sooner toward normalization of interest rates so that the stressed areas of the economy (i.e. real estate, consumers) can begin to heal.
To learn more, see CBIZ PE Advisory M&A Update - Q2 2024
[1] The Magnificent Seven: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla
[2] As of 7/11/2024
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