Bulls closed the first trading week of 2023 on a high note, pushing the Dow Jones Industrial Average up 700+ points on Friday. Lighter wage gains in the December nonfarm payrolls report and an unexpected contraction in the services sector helped spur investors off the sidelines on hopes slowing economic growth will prompt the Federal Reserve to reverse course on planned rate hikes. The jobs and wage news offset a solid Job Openings and Labor Turnover Survey (JOLTs) earlier in the week which showed demand for labor remaining high despite the Fed’s monetary tightening and concerns the economy will slide into recession this year. On the demand side, the services sector joined the manufacturing sector with both now having slid into contraction territory in December. The new year has brought with it an air of optimism that the Fed will be forced to pivot sooner than they’ve previously indicated in 2023, which found investors quick to push the Dow up 1.54% for the first week of the year.
Jobs Data Provides JOLT then Relief
The jobs market remained remarkably strong in December despite rising interest rates and signs of cooling demand for goods and services. Nonfarm payrolls increased by 223K, beating the Dow Jones estimate of 200K. The unemployment rate also dropped to 3.50%, nearing its lowest point in fifty years. The unemployment rate declined by 0.2% for the month, which was also better than expected. It was the wage gains growth that had markets cheering on Friday, however. Wages rose 4.60% yoy. This was below the estimate of 5.00% and lower than November’s 4.80% yoy rate. For context, the peak for this cycle occurred in March 2022 when wages were growing at 5.62% year over year. Jobs growth remains broad-based with leisure and hospitality (67K), healthcare (55K), construction (28K), and social assistance (20K) leading the way. The December jobs report comes on the heels of a hot JOLTS report which showed continued high demand for workers. In November, there were 10.46 million job openings, which was only down slightly from October’s 10.5 million, and was a disappointment for markets. Open positions outnumbered available workers 1.74 to 1. There was also little indication of substantial labor market softening as the number of hires and total separations were little changed at 6.1 million and 5.9 million, respectively. Surprisingly, despite the rising risk of recession, workers were quick to brush off those concerns and continued to seek out other opportunities. Quit rates rose in November from October. That was the first time since March that the metric has increased. The JOLTs report is closely watch by Fed officials for signs of labor market slack. The latest report combined with the December jobs print suggests a still relatively healthy labor market.
Consumers Tap Out
Inflation seems to have finally got the best of consumers in December, pushing down demand at both manufacturing and services firms. The ISM Manufacturing Index dropped to 48.4 in December from 49.0 in November. Numbers above 50 indicate expansion while numbers below indicate contraction. Slowing demand for new orders, exports, and production led to a decline in manufacturing activity in December. Despite the drop in activity, factories continued to add to their headcount during the month. The jobs index component of the reading rose 3 points to 51.4 as companies found it easier to hire much needed talent. On a continued positive note, inflationary pressures continued to ease as the prices index declined to 39.4, a drop of 3.6 points. On the services side, services activity contracted for the first time in more than 2-1/2 years in December. Weakening demand pushed the ISM Services Index to 49.6, down from November’s 56.5. New orders plunged, falling to 45.2 from 56.0 in November. That was the lowest level since May 2020. The drop in demand did have a silver lining, with the prices index dropping to 67.6, the lowest since January 2021, from 70 in November. Overall, the Fed’s rate hikes do appear to be making their way through the economy, continuing to slow the demand for goods and now beginning to hit the recently hot in demand services sector.
Final Thoughts
Investors picked up where they left off in 2022, rallying on news of a cooling economy. This week, investors cheered slowing wage gains and an unexpectedly weak services report that indicated a deceleration in economic momentum. These reports sparked bullish optimism that the Fed will be forced to pivot to a less restrictive policy stance sooner than the Fed has indicated. This optimism will probably be found to be short-lived. First, you just don’t fight the Fed. Although wage gains showed signs of slowing, at a 4.60% yoy rate, wage growth remains elevated. The Fed is likely to continue focusing on the fact that the overall labor market is unquestionably tight. Companies are continuing to add new hires, the number of available openings per worker remains high, and worker quit rates remain elevated. A quick Fed pivot also risks reigniting a wage-price spiral that the central bank has fought so hard to contain. Inflation, while decelerating, remains stubbornly high at an annualized rate of 7.10% – well above the Fed’s 2.00% target level. Lastly, and perhaps most importantly, the Fed believes unemployment needs to rise to 4.5%-5.0% to contain inflation. Whether they are right about that specific range or not, this is their stated position for the time being and the Fed has not yet given any daylight to the pivot argument, making the market premature in its optimism. Current rates have yet to fully ripple through the economy and the Fed’s expected 4.5-5.0% unemployment projection is often associated with recessions. The market’s near-term optimism over the Fed pivoting due to weakening economic data might just be replaced by new concerns over the severity of a potential recession in the weeks ahead.
The Week Ahead
After a healthy start to 2023, stock market bulls will look to maintain their momentum as the Q4 2022 earnings season kicks off. Investors will look to financial giants JPMorgan and Bank of America to set a positive early tone for earnings. In economic news, all eyes will be on the December CPI report for further confirmation inflationary pressures continue to ease. Global trade will also be on deck as traders pour over China trade figures.
The SECURE Act 2.0: Changes Affecting Retirement Planning
The SECURE Act 2.0, which stands for Setting Every Community Up for Retirement Enhancement, took effect January 1, 2023, three years following the original SECURE Act passed in 2019. It was signed into law on December 30, 2022, as part of a $1.7 trillion 2023 federal spending bill. The omnibus package includes defense funding, reforms to the electoral vote-counting law, additional aid for Ukraine and NATO allies, domestic emergency disaster assistance, funding for education, affordable housing, and healthcare, and many other provisions and earmarks. It also contains many revisions affecting retirement saving. Below are a few highlights of the retirement changes in the legislation, but check with your tax advisor and your financial advisor to discuss how these changes may affect you based on your individual circumstances:
1. The age at which individuals must begin taking a Required Minimum Distribution (RMD) from their tax-deferred retirement savings accounts increases to age 73 in 2023 and up to age 75 by 2033. That’s a big leap from just a few years ago when the RMD age was 70 1/2 before the original SECURE Act bumped it to 72 starting in 2020. This change will help workers to keep saving for longer should they choose. RMDs were first established in the 1980s to prevent workers from keeping funds in qualified retirement accounts indefinitely and avoid paying taxes on those funds. The mandated withdrawals are intended to ensure individuals spend their retirement savings during their lifetime and not use their retirement plans to transfer wealth to beneficiaries. RMDs are treated as taxable income, and the annual withdrawal amount is calculated based on age, life expectancy, and account value.
2. Before SECURE 2.0, failing to take an RMD triggered one of the steepest penalties in the entire U.S. tax code of 50% of the amount not withdrawn. The steep penalty for missing an RMD is reduced under the new law to 25%. Additionally, if the RMD is corrected in a timely manner, the penalty may be reduced to 10%.
3. The 401(k) catch-up contribution for those 50 and older increases from $6,500 in 2022 to $7,500 in 2023.
4. A special catch-up contribution for taxpayers between the ages of 60 and 63 will allow those nearing retirement to contribute up to $10,000 annually to a workplace plan starting January 1, 2025. The amount will be indexed to inflation.
5. IRAs already have a $1,000 catch-up contribution for people age 50 and over that has been in place since 2006, but the $1,000 limit will automatically adjust for inflation beginning in 2024 which means it may increase yearly.
6. Typically, withdrawals from retirement accounts prior to certain ages face a 10% penalty on the amount withdrawn. SECURE 2.0 introduces several new emergency and hardship-related exceptions to the early withdrawal penalty.
7. Starting in 2024, employers will be able to “match” employee student loan payments to a retirement account, giving workers an extra incentive to save while paying off educational loans. This will be at the employer’s discretion.
8. Employers may add an emergency savings account for non-highly compensated employees to be able to defer 3% up to a maximum of $2,400 annually to encourage workers to save for unexpected expenses.
9. Part-time employees who work for 500 hours or more for two consecutive years may be eligible to participate in salary deferrals under their employer’s 401(k) plan. Previously, the threshold for eligibility for part-time staff was 500 to 999 hours of work for three consecutive years or 1,000 hours in a 12-month period under the original SECURE Act.
10. The legislation requires most new 401(k) and 403(b) plans to automatically enroll eligible employees with a minimum 3% contribution beginning in 2025. Employees have the option to opt out.
This does not reflect all of the dozens of provisions of the SECURE Act 2.0, but the big takeaway is that the legislation gives workers more ways to save for retirement and implements changes that can affect investing strategies. An advisor can help you determine how the changes may affect your retirement plan.