To Inform:

We all remember the story of Goldilocks and the Three Bears. Goldilocks sought food and shelter in the home of the bears and found that porridge and bedding had to be just right to make her happy. Scientists and researchers have applied the “just right” principle to things like astrobiology, medicine, childhood development, and economics and markets. We’ll focus on markets today and try to determine if this is a market Goldilocks would approve of or if there is more work to be done to make things “just right.”

As far as the application to markets is concerned, a Goldilocks environment is one in which growth is neither too weak nor too strong, and inflation is neither too low nor too high. Some may say any level of inflation is too high, but that’s an argument for another day (and one the Fed isn’t willing to argue).

Let’s look first at the growth side of the question. Today’s news of 272,000 jobs created in the month of May surpassed analysts’ expectations and is supportive of economic growth. Growth is what Goldilocks is looking for. A primary concern in the last few years, however, has been a labor market that is too hot which could push up inflation and force the Federal Reserve to continue hiking rates or at the very least forestall their plan to cut rates.

Despite the market’s reaction to today’s jobs report (rate cut expectations are dropping) there’s more than meets the eye here, and I think Goldilocks may be pleased with the situation. While job growth continues, job openings are normalizing to levels seen prior to the COVID-19 pandemic. To us, this indicates a labor market with good balance – neither too few (2009-2013) nor too many (2021-2023) unfilled jobs. The labor market’s contribution to economic growth seems “just right.”

Source: Strategas

As far as inflation is concerned, Goldilocks is still waiting for the porridge to cool. Today’s jobs report included a reading of the employment cost index, which, when too high, can be a contributor to services inflation. While off the peaks seen in 2022, the employment cost index still remains stubbornly higher than what was seen in the low inflation regime from 2009 to 2020. For the Fed to feel confident in cutting rates, this number likely needs to trend to levels below 4%.

Source: Strategas

Goldilocks unfortunately will need to keep waiting for that “just right” market. While economic growth looks set to continue at a reasonably moderate pace, inflationary pressures remain too strong. Our hope is that the inflation “porridge” can cool while the growth “porridge” can remain warm enough to be palatable. This outcome is the much hoped for soft landing that market participants have been talking about since inflation began surging in 2022. Our hope is that Goldilocks finds growth and inflation to be the right temperature sometime this year. In such a scenario we expect the returns to investors in balanced portfolios of stocks and bonds to be a nice bed to sleep on.

Written by Alex Durbin, CFA, Chief Investment Officer