The S&P has rebounded 4.6% from its post-payroll low, and smaller caps are up even more (the equally weighted S&P is +5.1%). Risk assets tailwinds improved further after weaker than feared inflation readings increased the chance of a goldilocks scenario of strong growth and contained inflation.
Lower unemployment readings favor more Risk-on and Value-driven internals. That has been the case for most of the past few years, though that relationship is at risk IF stronger employment readings become associated with firmer inflation expectations. So far, inflation expectations have been largely unresponsive to minor changes in payrolls. A binary impact matrix from unemployment and inflation readings tendencies based on factor and sector sensitivities is outlined below. This is meant as a quick cheat sheet.
Combining sensitivities to unemployment and inflation, a lower unemployment rate together with stable inflation favors Energy, REITs, and Financials while Communications, Tech and Health Care underperform. Higher unemployment and in line inflation led those sector performances to reverse.
Rotations within factors have been less dramatic than within sectors this month. Market internals did rotate, favoring Risk-on and Value factors at the expense of Growth leadership. A continued goldilocks backdrop should favor a further Value and Risk-on rotation. Inflation and tariff risks will add volatility to those trends though.
Internal Rotation on Unemployment & Inflation Moves: The S&P has rebounded 4.6% from its post-payroll low, and smaller caps are up even more (the equally weighted S&P is +5.1%). Risk assets tailwinds improved further after weaker than feared inflation readings increased the chance of a goldilocks scenario of strong growth and contained inflation. Inflation and payroll readings will remain important factor influencing headline markets and internal rotations until uncertainty related to tariffs and the Fed’s reaction function eases.
Sectors that benefit most from weaker employment are Early Cyclicals, especially Communications and Technology, which are more Growth exposed sectors. Energy, REITs, and Financials are more likely to benefit from stronger employment and general growth trends.
At the factor level, Low Volatility, Momentum, and Growth have the strongest sensitivity to weaker employment data. Lower unemployment readings favor more Risk-on and Value-driven internals. That has been the case for most of the past few years, though that relationship is at risk IF stronger employment readings become associated with firmer inflation expectations. So far, inflation expectations have been largely unresponsive to minor changes in payrolls.
Sensitivities to inflation readings are largely reversed. Deep Cyclicals and Defensives benefit from higher inflation, while Early Cyclicals, especially Communications and Discretionary, do better when inflation trends lower. In most periods over the past few years, high inflation has led to concerns that financial conditions need to tighten. That has left higher inflation associated with more Defensive/risk-averse market internals. We see little reason to expect that relationship to change near-term.
That has led to a more mixed factor sensitivity to inflation. Risk factors have lower betas with inflation readings, and their sensitivities to core CPI and PCE readings have diverged. Fundamental factors, including Growth Momentum, Value, and Growth, have more consistent positive sensitivities to inflation, reflecting long-term support from an expansionary macro backdrop.
Combining sensitivities to unemployment and inflation, a lower unemployment rate together with stable inflation favors Energy, REITs, and Financials while Communications, Tech and Health Care underperform. Higher unemployment and in-line inflation led those sector performances to reverse.
Rotations within factors have been less dramatic this month. Market internals did rotate, favoring Risk-on and Value factors at the expense of Growth leadership. A continued goldilocks backdrop should favor a further Value and Risk-on rotation. Inflation and tariff risks will add volatility to those trends though.
A binary impact matrix from unemployment and inflation readings tendencies based on factor and sector sensitivities are listed below.
