A Weak Jobs Report the Market Chose to Look Past
The latest monthly jobs data was, plainly, not good. Payrolls came in at 57,000 versus expectations of 113,000 — barely half of what was anticipated. Compounding the disappointment, the prior month was revised down by roughly 74,000. On a net-net basis, that combination effectively removed about 120,000 jobs from the picture. Despite this, the market appeared to look at the report and see past it, with only a modest reaction.
One of the more revealing details is that the unemployment rate improved for the wrong reason. The jobless rate fell to 4.2%, but that decline was not driven by strength in hiring. Instead, it was the labor participation rate falling to 61.5% that flattered the number. A large part of that drop came from prime-age participation, which fell to 83.3%. In other words, the improvement in the headline unemployment figure reflected people leaving the labor force rather than finding work.
The market's response was to pull back expectations somewhat — trimming the odds of a Fed policy move in October. This was a noticeable, though not dramatic, downtick in the hawkish policy that had been priced in. The 10-year Treasury yield vacillated around 4.45%, so there was no large move there. Equities got a small bump on the morning of the release, but that gain appeared to fade fairly quickly.
The Fed's Likely Path: On Hold and Waiting for Data
Was that modest repricing of policy expectations the right response? The reasonable read is yes. While it clearly was not a good jobs report, an important caveat is that one report does not necessarily make a trend. The revisions are notable and arguably take some of the steam out of the prior month's stellar report, but they don't by themselves establish a new direction.
Viewed through the eyes of the Fed, the more persuasive conclusion is that the central bank is likely to remain on hold for the rest of the year. Inflation continues to be elevated, but there are some signs of easing pressure. Oil prices have pulled back, and while that hasn't translated much into gasoline prices yet, it could eventually put some easing pressure on the inflation side.
Because this report was not particularly strong, it actually gives the Fed a bit more runway to wait for incoming data before deciding where to move next — and, importantly, to avoid the mistake of moving too early. The softness in the labor data, paradoxically, buys the Fed patience.
Semiconductor Volatility and Index Concentration
In the twenty minutes or so before the discussion, semiconductor chips took a sharp spill to the downside. This matters enormously because nearly 20% of the S&P 500 is comprised of those names — a concentration that is now roughly double what it was during the dot-com era. That degree of weighting makes the index vulnerable to swings in a single, volatile sector.
Is this simply something investors must live with if they are broadly invested in the S&P 500? Largely, yes. Much of the volatility can be attributed to leveraged ETFs and the sheer concentration of exposure — not only in the U.S. but also in some Asian markets, specifically Korea. Over the preceding couple of weeks, Korea saw a couple of "limit down" days where trading curbs were put in place because of the advanced selling that had occurred.
To put the moves in context, the semiconductor ETF (SMH) was up about 72% in the first half of the year. After a run like that, some give-back makes sense. The sector was down about 5% the day prior, and individual components — Micron and SanDisk among them — fell 10% or more in a single session. The takeaway is that there is going to be chop. When a group moves as quickly to the upside as this one did, that does not mean everything has to give it all back, but continued volatility going forward should be expected.
Where the Opportunities Sit in Fixed Income
With yields having inched higher, investors looking to clip some coupons face a question of where to position on the curve and across credit quality. A useful framework is to break a fixed-income portfolio into two parts: a core fixed-income allocation and a more aggressive income sleeve. For an investor seeking to boost yield further, the aggressive sector is the place to look — but that sleeve should be capped at no more than 20% of the fixed-income portfolio.
On the core side, the more favorable area right now is investment-grade corporate bonds. There are two reasons for this. First, yields have moved up. Even though they have come down a little recently, they remain elevated relative to where they have been over the past couple of years, which makes those absolute yields fairly attractive in the current environment. Second, corporate credit quality overall has been relatively improving, and the economy continues to act as a tailwind.
This ties directly back to the jobs report. A great deal has been thrown at the economy, and while the report was bad, one clear positive is that the economy does continue to add jobs. So long as that remains true, it is likely that individuals will keep spending and continue to serve as the growth driver going forward — which supports the credit backdrop for corporate bonds.
On the aggressive side, the more favorable areas are preferred securities and high-yield corporate bonds. The story is similar: absolute yields remain relatively attractive, and the economy continues to be a tailwind. The important caveat is that tight spreads are a potential risk in this space. That makes selectivity essential, and investors with a higher risk tolerance who venture here should be fully aware of that spread risk.
The Bottom Line
The June jobs data was weak on the surface and weaker underneath, with downward revisions and a participation-driven decline in unemployment. Yet the muted market reaction and the resulting patience it affords the Fed suggest a central bank likely to stay on hold through year-end. The semiconductor sector's volatility is the flip side of its extraordinary first-half gains and its outsized weight in the index — a feature broad-market investors will have to tolerate. Meanwhile, elevated yields and a still-growing, job-adding economy make investment-grade corporates the preferred core holding, with preferreds and high yield offering additional income for those willing to accept the risk embedded in tight spreads.
