Why a stock market obsessed with the Fed’s inflation fight should focus on Main Street jobs in 2023

Fortunes on Wall Street this year could hinge less on what’s happening to high-paid workers in San Francisco’s reeling technology sector and more on a familiar part of American life: the working class.

Investors wondering if it’s time to buy battered stocks have seen hopeful signs in U.S. costs of living receding from their highest level in 40 years. Bulls got another shot in the arm Friday after a robust jobs report for December also showed slowing wage growth.

The Dow Jones Industrial Average

booked a gain of 700 points, while the S&P 500 index

and Nasdaq Composite

 snapped a four-week losing streak.

The problem? While the Fed has quickly raised interest rates since March, the central bank still needs to find a way to cool the economy, but not by too much, and an end to a vicious cycle where high wages feed painful levels of inflation, potentially for years to come.

“It’s still important to keep perspective,” said Alexandra Wilson-Elizondo, head of multi-asset retail investing at Goldman Sachs Asset Management, in a phone interview Friday. “Wages are still high.”

With that backdrop, she thinks unemployment needs to rise for the Fed to get back on a path to its 2% annual inflation goal, and that the U.S. will enter a mild recession.

“It’s way too early to claim victory.”

Tech isn’t the economy

Technology companies, a major source of pandemic stock-market gains, have switched to enduring the blight of layoffs.

Amazon.com Inc.

this week confirmed total cuts of 18,000, while Salesforce Inc.

said it would reduce its staff by about 10%, adding to a barrage of pink slips across many of the biggest names in tech.

Read: Here are the companies in the layoffs spotlight: Amazon joins Salesforce, Intel, Google, HP, Cisco

But forces hammering the tech sector don’t paint a full picture of the labor market. Friday’s payroll report showed the U.S. economy added 223,000 new jobs in December, while the 3.5% unemployment rate matched its lowest level since 1969. Furthermore, hourly wage gains were modest, sparking hope that pay for workers might be leveling off, potentially allowing the broader economy to avert a recession.

A word of caution: as with the Fed’s main gauge of housing inflation, the central bank traditionally has been focused on labor statistics that are backward looking to help shape monetary policy.

Another facet has been that a decade of low interest rates and a deluge of pandemic fiscal and monetary stimulus has made this economic slowdown look anything but ordinary.

Unlike prior periods when the economy looked poised for a recession, Steven Blitz, chief U.S. Economist at TS Lombard, noted this slowdown has seen a deterioration in higher paying “white collar” jobs , which has led the way to lower employment growth, in a Friday client note.

There are several reasons why investors might want to take notice. “The one thing we are seeing is the massive dichotomy in different sectors of the economy,” said Allie Kelly, chief marketing officer at Employ Inc., a large-scale provider of real-time hiring data, in a phone interview.

While high paying technology and financial companies have been in the headlines for layoffs, “In reality, tech companies only make up about 2% of our total jobs,” she said. “Leisure and hospitality are furiously growing,” she said, adding that another quirk has been growth in construction jobs, even with the slump in the housing market.

“I think we are doing ourselves a disservice to not look under the hood of the jobs market,” Kelly said.

Who has jobs matters

Fed Chairman Jerome Powell’s sharp focus lately on the near 5% hourly wage increases comes as consumer inflation data has been more mild, suggesting the worst inflation since the 1980s might have passed.

Stephen Dover, chief market strategist and head of the Franklin Templeton Institute, said that while inflation was the primary issue for investors in 2022, how people are paid going forward, and who gets hit by unemployment, should be key areas of focus in the months ahead.

“That has implications for how we invest and what companies are going to do well,” Dover said.

Wilson-Elizondo at Goldman said she still expects the effects of the Fed’s higher interest rates to show up more acutely in coming corporate earnings reports, and potentially for pockets of stress in credit markets to emerge as it drains more liquidity from the system.

“One of the harder parts of the Fed being data dependent is that each point that comes out will lead to larger swings in markets, if it’s not what is expected,” she said.

Investors next week will be glued to December’s consumer-price index due Thursday, with the headline annual rate expected to fall to 6.6% from 7.1% in November, a retreat from its peak above 9% in the summer. They also will hear from several U.S. central bankers, including Chair Powell on Tuesday speaking in Sweden.

For the week, the S&P 500 and Dow recorded their best weekly percentage gains in six weeks, up 1.5% each, according to Dow Jones Market Data, while the Nasdaq Composite rose 1%.