SUMMARY
Despite the current strength of US employment, we believe the jobs market is set for slowdown. With such cyclical risks getting priced in, we believe return prospects are improving for small- and mid-cap equities.
- Employment gains in May were nearly twice as large as forecasters anticipated. Equities have rallied on the expectation that labor market gains can outlast the Fed’s tightening impacts on the broader economy. In a rolling recession scenario, the economy may escape a plunge, but we’re skeptical that recessionary industries under profit pressure can maintain their hiring pace. We believe a net slowdown in employment is ahead.
- Now that the debt ceiling dilemma is resolved, there will be a net increase in US Treasury bill issuance of perhaps $400 billion in the near term. The bulk of the new issuance is in shorter-duration bills. These have the highest yields and compete most directly for bank deposits.
- The potential for higher yields to siphon away deposits from weaker US banks is significant. A shift from bank deposits to US Treasuries should not necessarily result in new bank failures, but the systemic risk for banks may rise again despite the 4.8% rally in regional bank shares this week.
- Potential return opportunities in small and midcap (SMID) shares are brightening. SMID’s tepid performance over the past two years has left profitable small cap names now trading at a 26% discount to larger peers. While large cap growth shares have rallied in 2023, fast-growing small firms remain in the doldrums.
- Value and defensive sectors were winning investing plays in 2022, with dividend growth shares outperforming the broad market by 12%. As economic and profit growth stalls and bottoms over the next few quarters, the end of 2023 may mark the twilight of the defensive trade.
