Here's the reason behind this week's stock turnaround

Stock markets tried their best Wednesday to maintain a two-day rally that saw some of the biggest single-day gains since April 2020, when markets initially rebounded from shutdowns in the early days of the coronavirus pandemic. 

The Dow Jones Industrial Average closed down 41 points at 30,274 Wednesday, after dipping more than 400 points in the morning trading session. The S&P 500 stayed about level, dipping 0.2 percent after rising 5.6 percent on Monday and Tuesday.  

The rally earlier this week, which saw the Dow rise more than 1,500 points, was due in large part to a report from the Labor Department that high levels of employment within the U.S. economy may be declining — a sign that the Federal Reserve could potentially discontinue hiking interest rates to battle record inflation.  

But additional employment data released Wednesday indicated that the strong job market may not in fact be leveling off, suggesting that the Fed will continue to raise interest rates by an anticipated 75 basis points until surer signs of diminishing inflation emerge. 

Payroll services firm ADP reported Wednesday that U.S. companies added 208,000 jobs in September, beating economists’ expectations by 4 percent and growing from August’s number of 185,000 jobs added. 

“There are signs that people are returning to the labor market. We’re in an interim period where we’re going to continue to see steady job gains. Employer demand remains robust and the supply of workers is improving — for now,” Nela Richardson, ADP’s head economist, said in a statement Wednesday. 

The ISM services sector survey also came out Wednesday and showed rising job numbers, with the employment index at 53 percent, up 2.8 percentage points on the month. 

"Labor pressures continue to depress business activity, as insufficient staffing levels are not allowing the hospital system to operate at capacity,” one survey respondent in the health care and social assistance sector noted to ISM. 

"Hiring continues to be a challenge across most industry sectors,” another respondent from the scientific sector said. “There are far more open roles than candidates to fill them. Due to inflationary concerns, companies are being cautious about hiring direct employees and are attempting to utilize contingent labor. The lack of candidates willing to fill temporary positions is making this strategy difficult to execute." 

But job market data from earlier in the week told a different story. 

The ISM manufacturing sector survey, which came out Monday, showed manufacturing jobs falling 5.5 percentage points on the month, leaving the index at 48.7 percent. 

Job openings reported Tuesday by the Department of Labor also indicated some potential slackening of the labor market, falling from 11.2 million openings in July to 10.1 million in August, a decline of more than 10 percent — the sharpest decline since the beginning of the pandemic. 

These moves together propelled the Dow up 5.5 percent from Friday to Tuesday on hopes that the Fed would be appeased by the direction the labor market was heading and feel less of a need to make its fourth three-quarter-point rate hike in a row at its meeting in early November. 

“In just the last couple days, given that soft data, the market’s erased expectations of almost 40 basis points on rate increases. That is significant. That’s the market screaming that it wanted to see weakening economic data so that the Fed can slow down,” Edward Moya, an analyst with brokerage OANDA, said in an interview. 

But Wednesday’s tighter job numbers jostled investor confidence, causing the Dow to fall more than 400 points in morning trading before the index slowly worked its way back up to nearly break-even territory. 

Some market watchers have also pointed to the upcoming third-quarter earnings seasons as a reason that investor confidence may be rebounding. 

“Whatever rates do in the short term can dictate what equity prices do in the short term as well,” Mike Wilson, an investor with Morgan Stanley, told the Bloomberg television network on Sept. 27. “And so if we get a rally in the backend, which should happen from here, then stocks could get a little lift here into earnings season.” 

But analysts agree that excitement about a weakening labor market is fundamentally what’s behind this week’s market rally, advancing the hope that weaker job numbers may cause the Fed to back off its rate hiking program. 

A softer labor market could also mean slowed growth in the wages that companies need to pay their workers. Nominal wages have increased 5.2 percent over the past year and are frequently associated with higher prices by Fed bankers. 

Asked at a press conference in September how long Americans should be prepared to feel economic pain resulting from interest rate hikes, Powell responded, “How long? I mean it really depends on how long it takes for wages and, more than that, prices to come down for inflation to come down.” 

Many voices on Wall Street see the bear market continuing after the current rally subsides, viewing a recession, also called a “hard landing,” as inevitable. 

“Based on our client discussions, a majority of equity investors have adopted the view that a hard landing scenario is inevitable and their focus is on the timing, magnitude, and duration of a potential recession and investment strategies for that outlook,” Goldman Sachs analysts David Kostin and Ben Snider wrote in a September analysis for investors. 

In drawing up potential scenarios for the S&P 500, the analysts modeled a “soft landing” option for the index bottoming out around 3,600 at the end of 2022 before climbing back to around 4,000 at the end of 2023. The hard landing scenario has the index dipping closer to 3,100 in mid-2023 before closing out next year around 3,750. 

Anticipating further rate hikes, OANDA’s Moya said that he’s “locked into 75 basis points, unless next week’s inflation report comes in significantly softer, and I don’t think that’s going to happen.”