JACK JANASIEWICZ: I'm Jack Janasiewicz.

BRIAN HESS: I'm Brian Hess. And this is Tactical Take.

Well, Jack, it's been a long time since we've sat down to do a podcast between summer travel and some business travel as well. So we should have plenty to talk about today. And I thought maybe we'd start with the US labor market, where at the beginning of August, we got the July report. And in and of itself, it was pretty good. We added 73,000 jobs, which is a little less than we have been adding. And not a huge number for monthly job gains, but good enough.

However, the big story was in the downward revisions to the May and June data, where we ended up with 258,000 fewer jobs than we thought upon the initial release. So is this a red flag for the labor market? How are we seeing that big, dramatic change in the May and June job picture, which brings a three-month moving average to a much lower level and shows that the labor market seems to have stalled out?

JACK JANASIEWICZ: Yeah, this is something that we've been trying to highlight for a couple months now, that we certainly expected a sequential slowing coming from the jobs market. And we finally got it. Put some perspective around those revisions, though. You're talking about, what, 160 million, 170 million people in the workforce in the United States. So when you have a revision of 258,000 relative to 160 million, that's still a pretty small number. So a little bit of context around that.

But I think what's worth talking about is just the guts of that report. Because when you start to peel back the layers, and we've been saying this for quite some time now, the intricacies within there are really weak. And I think that's the key takeaway here.

And I think the risk – and we've heard this from Waller talk about this in the past, Fed Governor Waller, that when the labor market begins to slow, it can slow precipitously faster. And that's, I think, a key risk for the Fed going forward.

But I think a couple of things that are worth highlighting there. One, obviously, payroll growth continues to slow. If you look at the underlying breadth within those job ads, they've been deteriorating so the job ads continue to narrow.

BRIAN HESS: So that's industries.

JACK JANASIEWICZ: Yep. So you're –

BRIAN HESS: What percentage of industries are seeing job gains?

JACK JANASIEWICZ: Correct. And when we split that up, there's actually the jobs growth diffusion index. It's just looking at all the break-evens for each sector, so to speak. And that continues to head lower. And it's really being driven by what we call the acyclical portion of the economy. You're thinking of things that are like education, social services, health care, that portions of the market which are somewhat immune to the ebbs and flows of the cycles.

From an economist standpoint, our key indicators there would be more on the cyclical side. So you'd be looking to see adds from manufacturing, transportation, that side of the equation. And we're just not seeing that. So from that perspective, it's a little bit concerning that we're seeing job adds really not in the portions that we would like to see it, which implies slower growth.

And then the last one worth highlighting is just the participation rate. Basically, the number of people who are employed in those various sectors relative to the broad population, those are actually going lower. And so put all these things together, you're seeing a sequential slowdown in the labor market. And that's going to be a concern going forward – something to pay attention to.

BRIAN HESS: Now, one byproduct of the report is that Erika McEntarfer who was the commissioner of the Bureau of Labor Statistics, ended up being fired due to the revisions and replaced by a Trump supporter, EJ Antoni. Do you think there'll be any major developments with the new commissioner?

JACK JANASIEWICZ: Yeah, again, going back to the comments there. It's always hard to basically estimate 160 million people. So you're going to have revisions. And I'm sure if you follow the economy, everybody kind of knows some of the current issues that we've been seeing, one being just the survey response rate. It's been going lower basically since COVID.

And one of the things I think worth highlighting, though, is you get initial reads, and then you get subsequent revisions. It's the first print, the first look at advance retail sales. We see that across a lot of major economic prints.

It's the same thing on the jobs front. We just don't call it the advanced jobs data, so to speak. So we know that revision's coming. And unfortunately, this got a little bit politicized, and it makes it challenging. 

So the point here, though, is that we should be expecting revisions. The revisions tend to go with the economy. So if we're seeing an accelerating economy, those revisions tend to be the upside. If we're slowing, they tend to be to the downside.

Sure, maybe we can get better participation, better response rates that would help collect that data more efficiently. But it's all said and done. This is still the gold standard in terms of economic data and collection. And I don't think we should be really trying to politicize this for some of the issues that we're seeing coming across the headlines here. The numbers are pretty good.

BRIAN HESS: Yeah. I mean, it's a big revision compared with history. You don't see that size of revision very often. But –

JACK JANASIEWICZ: Yeah. Maybe one other thing worth talking about there is all the ancillary data supports this as well. You look at the ISM (Institute for Supply Management manufacturing index) numbers showing some softness there, the ADP (Automatic Data Processing national employment report) numbers, some weakness there. So it's not like you had one sort of anomaly. You look at a lot of the mosaics here regarding the labor market, and you're seeing slowing across the board.

BRIAN HESS: It's more like the initial prints in May and June were surprisingly strong, and these revisions bring them more in line with what we would have expected –

JACK JANASIEWICZ: 100%.

BRIAN HESS: – anyway. And at the same time, while there's not a lot of job creation it seems like, at least we're not seeing a lot of firings either. One economist we follow, I think he calls it the "no hire, no fire" labor market right now, which I think is a good –

JACK JANASIEWICZ: Yeah. It's spot on. Right.

BRIAN HESS:  –way of putting it.

JACK JANASIEWICZ: Yeah. And you see that again on the employment claims data. So when you look at initial jobless claims, they've been fairly stable. But continuing claims continue to ebb higher, which just tells you that if you don't have a job, the market is becoming very, very hard to actually get that job.

And I think what we've seen, too, coming out of COVID, it was very difficult to hire in terms of that labor force issue back then. And I think firms may be a little bit loath to actually let people go.

And so rather than maybe firing people, what you're seeing are maybe some of the workweek hours are dropping a little bit. You're certainly seeing wages come down. So I think there's other means that we're seeing to address that. But at the same time, to your point, we're just not seeing firings, at least not yet.

BRIAN HESS: And so that's why we're not getting the nonlinear reaction in the labor market. Like, if you go back and look at a chart of the unemployment rate, it's very stable, stable, stable, and then it goes vertical when you enter a recession. And we have not seen that non-linearity play out yet. And hopefully, we won't.

You mentioned hours worked and wages in passing there. And that brings to mind our focus on aggregate income and the metric we follow there to gauge spending power in the economy. There's definitely a slowdown going on within aggregate income. And that should bleed through to weaker retail sales at some point.

We got the July data on Friday, and it was surprisingly strong, I thought, given what we've seen going on in the labor market. Were you surprised by the retail sales figures at all?

JACK JANASIEWICZ: Yeah, I think maybe a touch lighter on the surface. And then you had upward revisions to the previous month. So I think in aggregate, maybe better than expected.

But to your point, that aggregate income that we continue to talk to – listen, people have jobs. They're going to spend it. And we're certainly seeing shifts underneath the surface in terms of those spending patterns. You're seeing maybe less on discretionary.

So I think the travel that we had, the revenge spend coming out of COVID, we're seeing that soften a little bit at the margin. But I think, in general, things are still holding up fairly well. But maybe some notables worth highlighting.

Restaurant sales certainly have ground to a halt. What was also interesting in that most recent print, nonstore retailers had a little bit of a pop there. But again, we had Amazon Prime Day. So maybe a little bit of an anomaly to think to. So maybe let's look forward with that.

But the other one too, I think you've seen some evidence of inflation. So thinking of things of furniture and home furnishings, they had a pretty good pop. But at the same time, when you look through the CPI (Consumer Price Index) or the inflation backdrop, that same cohort actually had a pretty significant jump. So –

BRIAN HESS: Yeah, it's a nominal –

JACK JANASIEWICZ: Nominal versus real.

BRIAN HESS: Retail sales is a nominal figure. So if you get big price rises, it might not mean there's more volume going through.

JACK JANASIEWICZ: Exactly. But you're seeing, I think, spotty – it's not homogeneous across the board there. So you had areas that saw a pop. Also saw a spike in prices. In some areas you saw a pop, and you didn't actually hit that spike in prices. So a little bit of a mixed bag across.

BRIAN HESS: Just like the labor market, where basically we're kind of waiting for things to get worse, and they're holding up at a decent level.

JACK JANASIEWICZ: Yep. Exactly.

BRIAN HESS: OK. Now, despite the July retail sales being pretty strong, as we just talked about, the economy overall has definitely gotten off to a slow start in the first half of this year. So one way of measuring growth that we like to look at – final sales to domestic purchasers. So this will strip out the effects of trade, which has been heavily distorted this year, and inventories also distorted by front-loading and things like that.

So if we look at final sales to domestic purchasers, it grew 1.5% in the first quarter and 1.1% in the second quarter, which is a major slowdown from basically the roughly 3% pace we had been doing from the third quarter of 2022, all the way through the end of last year. We went on a ten-quarter run of very strong growth. So that's a weak two-year reading.

And I think if we dig into the details – or weak two-quarter reading, rather. If we look into the details, housing remains just like frozen and not adding anything to the economy. Not necessarily taking away, but not adding.

Government spending has gone from a big tailwind where for much of that 10-quarter period I talked about, it was consistent, like adding half a percent, half a percent every quarter. It's moving into negative territory. And consumption is finally slowing dramatically.

So the personal consumption expenditures component of the overall economy, that only grew half a percent in Q1 and 1.4% in Q2. So again, another weak two-quarter reading. What do you think about the trajectory – with that as backdrop, how are we seeing the trajectory for the second half of the year? Was it just a blip, like a couple of weak quarters?

We had a bunch of years there where Q1 was always weak, if you remember, in the 2010s. It was like every first quarter. It was sometimes weather-related. But for whatever reason, it was always soft. Is the first half an anomaly, and we're going to re-accelerate? Or do you think we're getting more of this slowdown for the rest of the year?

JACK JANASIEWICZ: Yeah. And you went through a lot of the details spot-on. And I think the key thing to think about, too, is you need to look at it not just on a quarter-on-quarter basis, but because of the impact from tariffs, you had a lot of front-loading, a lot of people trying to get in front of the potential price hikes. So, I think a lot of the activity maybe was reflected more so in the first quarter. You got a significant slowdown in the second quarter. So look at the two together.

But in aggregate, when you combine those two quarters, it's slower. No doubt about it. Now, I think when we look at the trajectory going forward, and you combine it with things that we just talked about from a labor market perspective, if we continue to see a slowing, whether it be with jobs easing up, nominal wages moving lower, and if we get a little bit of a tick higher with inflation, that obviously means real spending is going to come down. And that consumption number is probably going to continue to be a drag. And I think from that real final domestic demand story that we were just talking about, that's probably put some downside pressure on that.

The key, though, maybe is simply rate cuts. And so I think the market is maybe looking out towards the back half of this year where you start to potentially see the cuts starting in September, getting a cut at November and December. Is that enough to put a floor under the market here? Possibly.

The trick will be actually a re-acceleration. And I think for that real acceleration to kick in, maybe we're starting to push that out to the beginning of 2025, where you get enough subsequent cuts that maybe the housing market actually does show some signs of life because mortgage rates do finally get below 6%, for example.

So, I don't think we're terrible, but at the same time, we're certainly slowing. Rate cuts could put at least a floor underneath growth. But the trick I think going forward is going to be could we see a potential re-acceleration? And the question mark then becomes, what would those catalysts be in 2026 for a re-acceleration?

BRIAN HESS: One area that's showing strength even now, even in the first half of this year, has been tech CapEx. So if we look at non-tech CapEx, that's in the housing category where it's not doing really much of anything, not contributing. But in Q2, tech CapEx actually contributed more to growth than consumption, which is remarkable because consumption represents 70% of the economy. So tech CapEx is punching way above its weight. And we know this is artificial intelligence related.

So how important is a continuation of that tech CapEx given that, yeah, we're talking about maybe lower interest rates can unlock some portions of the economy. Maybe housing gets a small lift. or maybe some of the non-tech CapEx picks up. But absent a major rate-cutting cycle, how important and dependent on the economy is – or is the economy on tech CapEx? And how sustainable do you think the current run rate is?

Because that's a big – if you look at a bar chart of tech CapEx contribution to GDP (Gross Domestic Product), it's an outlier. Normally, when you get an outlier in one direction, you get a payback in the other. So can tech CapEx carry the day?

JACK JANASIEWICZ: Yeah and I think again hit on a key point there. When you think about consumption and how big that is in aggregate relative to how big AI CapEx spend is, I mean, it dwarfs it. But it just shows you the incremental change. That's what's being reflected in that GDP number that you're talking about. That incremental change has been huge in terms of AI CapEx spend for its contribution to first and second quarter growth here in the US.

So that was one of the big things we were paying attention to when we were going through the earnings reports. You want to make sure those hyperscalers, whether it's Oracle, Microsoft, Amazon, Google, are they – Meta – are they still actually going out and making these big investments in CapEx on the AI front? And so far, based on what we heard from them during second quarter, yeah, it's going to continue.

So at least in the near term all evidence points to all systems go for AI CapEx spend. But to me the risk is potentially looking out if that AI CapEx starts to roll over. That's been such a, I guess, single engine of growth here in the United States, that if that starts to sputter, maybe that actually is the catalyst for a proper correction in the markets.

BRIAN HESS: So like a year ago, if we said, what's the biggest risk to the cycle, we probably would have said inflation or something like that. If we look back six months, or even a little farther than that, we probably would say tariffs, that trade policy is the biggest risk. It seems like right now tech CapEx and AI spend is probably the biggest risk if something goes wrong there.

There's not a lot of slack elsewhere. And I don't mean slack in terms of looseness in the economy. I mean, there's not a lot of other areas that are going to make up for the difference. So that's –

JACK JANASIEWICZ: Yeah, and maybe a few things that are worth pointing out. I think one, just looking at the ROIC, the Return on Invested Capital, coming from those hyperscalers, it's still north of 20%. If you look at the overall S&P average, it's around 9%. So from their perspective, at least they're still making a decent return on that investment. So maybe that's a good sign going forward, but something we're certainly paying attention to.

And the second one I get a lot of questions about trying to make the analogy between dot com days and today. Just remember that a lot – actually, almost all of what's being spent right now is coming out of free cash flow from these hyperscalers. You go back to the dot com days, and a lot of that was being financed through borrowing, so leverage.

And so yeah, it certainly at the surface would not be helpful if it rolls over. But at the same time, we're not talking about leverage and balance sheet concerns if this were to start to roll over aggressively. It just means free cash flow. Probably means –

BRIAN HESS: Means they maybe wasted some capital as opposed to creating a more systemic risk.

JACK JANASIEWICZ: Exactly. Exactly. And that's a key difference between today and the dot com comparison.

BRIAN HESS: That's good to point out, because the analogies to the late '90s are definitely picking up steam.

JACK JANASIEWICZ: Absolutely.

BRIAN HESS: And so maybe there's some similarities, but it's not exactly the same. You mentioned Q2 earnings in relation to the AI spending. But wrapping up Q2 earnings season, the results were largely positive, even away from the AI area. And forward expectations for the S&P 500, they just continue to grind higher. And this is interesting given the backdrop we highlighted with respect to growth.

I mean, do you worry that at some point this growth slowdown will manifest in maybe those expectations being difficult to achieve? Because that seems to me like what's helping the stocks just look through the weakness. It's the fact that yeah, we have a slower economy, but it's not impacting earnings.

JACK JANASIEWICZ: Yeah, and even when we start to look at the potential impact from tariffs coming through, you'd expect to see maybe margin compression at some point. But just looking at expectations for margin expansion going forward. We're pushing all-time highs, and it's certainly not rolling over.

So from that perspective, that operating leverage is going to flow right to the bottom line. And these are key themes that we're paying attention to that don't seem like they're about to roll over anytime soon.

BRIAN HESS: I'm laughing because if we're not seeing any inflation from – if the government's actually taking in tariff revenue, which they are. We're seeing that data. And if we're not getting inflation from it, somebody's paying that revenue. So it's like, is it not coming out of the margins of the people selling it here in the US? I guess some of it's coming out of the producer outside the US? Although, international stocks are also rallying strongly.

JACK JANASIEWICZ: Tough to quantify. I mean, I've seen a few of the Wall Street analysts putting out some research, basically showing that maybe it's been kind of equally shared across the board for everybody, which I think if you had talked to these same analysts at the beginning of the year, they would have probably said the bulk of that's going to be absorbed by the consumer.

So maybe the idea that it's being spread across the impact at the margin is still manageable, and that's maybe better than expected. And that's partly why we're continuing to see things just grinding higher.

BRIAN HESS: Yeah, maybe at every step of the production, we're able to absorb just a third of what the overall change would be and not have it be noticeable, as opposed to if the consumer had gotten hit with 70% or 80% of that tariff.

JACK JANASIEWICZ: Yep.

BRIAN HESS: All right. Well, we've covered a lot of ground already, but let's touch on one last topic just because the Fed is very much in the news lately. There's been a lot going on. And part of that conversation has to be around inflation. We've covered growth pretty extensively, but let's transition to inflation.

Last week we got the July CPI report, and it catalyzed a really big market reaction. It was viewed as tame enough to essentially allow the Fed to restart its rate-cutting cycle at the September meeting. Yesterday, I checked. We were priced for 85% likelihood that they cut in September.

And yet, headline CPI, it's still 2.7% year over year. Core CPI is at 3.1%. So both are well ahead of the 2% target. And even on a month over month basis, core inflation advanced 3/10 of a percent in July, which doesn't annualize to below 2%. Not even close. And it's accelerated for the second month in a row. We were 1/10 in May, 2/10 in June, 3/10 in July. So it's moving in that direction.

But I guess the key for this inflation report was that there wasn't a lot of evidence of the tariff showing up. Was that the big thing that catalyzed the big market reaction?

JACK JANASIEWICZ: Yeah, and I'm going to cheat here and read off my notes because I think it highlights what you're just talking about here. When I look at a lot of these line items, you're talking about household furnishings and supplies – up 7/10 of a percent, up 1% last month. Video and audio products – up 8/10 of a percent versus 1.1 the previous month. Sporting goods – up 4/10, up 1.4% the month prior.

Point being is all these things that should be impacted by tariffs, yeah, they're up, but they're up less than what we've seen in the previous months. So the point there is, again, maybe the tariff passthrough is not as bad as expected. And I think the markets are of breathing a sigh of relief here that, yeah, at the headline number, certainly we're still above the Fed's target. But we're not certainly aggressively starting to accelerate or re-accelerate in here.

And I think that, at the margin, might shift the balance of risks for the Fed because as we just talked about, the labor market is showing signs of softening. Maybe the balance of risk shifts a little bit away from price stability and really more focusing on the labor side of the mandate. And as a result, you have more of an impetus to cut rates in September.

BRIAN HESS: So it's all about maybe the worst of the tariff-driven inflation being behind us.

JACK JANASIEWICZ: Behind us. Exactly.

BRIAN HESS: And now the Fed can stop using that as an excuse for not responding to the slower growth.

JACK JANASIEWICZ: And I think the other key thing to think about too, the idea that tariffs act as a tax makes some sense because you're not seeing broad passthrough across everything. You're seeing it certainly in the goods portion, but the services side of the economy, you're not seeing that. So if this was a broad inflationary impulse, you should see it across the services side of the equation as well. And you're just not.

BRIAN HESS: Yeah, there aren't second round effects or anything creeping into the economy.

JACK JANASIEWICZ: Exactly. Yep.

BRIAN HESS: OK. And on the same day that July CPI came out, there was also an announcement regarding the composition of the board. So President Trump announced Stephen Miran as new member of the FOMC (Federal Open Market Committee) board, replacing Adriana Kugler, who resigned unexpectedly at the beginning of August.

Now, at the July meeting when the Fed did not lower interest rates, we had two dissents, and that's a pretty rare occurrence. There haven't been two dissents in years. So it looks like with Stephen Miran on the board, he'll be bringing with him a third dissent.

Do you think that tips the balance for the September meeting, where – I mean, the market's already priced aggressively for it, and the Fed usually doesn't disappoint with that setup. But three dissents would probably be a lot for Chairman Powell to ignore.

JACK JANASIEWICZ: Yeah. And I think you could start to add on – I think maybe Mary Daly was out saying that she's expecting cuts. And I think even we've heard from – well, who's at the Chicago – I'm drawing a blank on that. Who's over at Chicago there?

Anyway, I think what you're seeing is a move – more and more people are coming forward and basically moving to that rate cut backdrop. So from that perspective, I think you're certainly seeing the case building where there's going to be enough members on the committee to start pushing for a cut as well. So I wouldn't be surprised if those two dissents were maybe a month early. But I think you're getting more and more people on board to start to move to that cut.

BRIAN HESS: So you think the Fed's a lock for September?

JACK JANASIEWICZ: I wish I could be 100% on board with a lock, but I would say it's pretty high in our base case scenario.

BRIAN HESS: We'll see what happens. I think the press conference will be very interesting just to see how Trump maneuver – or not Trump – but Powell maneuvers through all these crosscurrents, which he's been in the hot seat for sure.

JACK JANASIEWICZ: Yeah. And the other thing to keep in mind, the Fed, it's a voting committee. And so just by putting pressure on Powell, or by bringing in and doing the shadow Fed Chair, you still need to get all the other members of the FOMC on board with rate cuts. And so it's not quite as –

BRIAN HESS: There are 19 members, I think.

JACK JANASIEWICZ: It's not quite as easy to make that move, to get that sort of dovish tilt that President Trump is hoping for. That's for sure.

BRIAN HESS: Exactly. Now, someone who I think does view this September meeting as a lock is Treasury Secretary Bessent, who was on TV last week and suggested that they might even do one to do 50. Because if they have the employment data without the revisions in hand at the July meeting, like if they knew those 200 and some thousand jobs didn't exist, they may have cut in the July meeting.

So the fact that they didn't that. Now they do. They didn't cut. They should make up for it and do 50. He also highlighted that some interest rate models he's looking at suggest a real policy rate that should be 150 – or a neutral policy rate that should be 150 to 175 basis points lower than where it is, which would bring the policy rate to right around 3%, or even maybe a touch below it.

So, there was a big leadership shift in reaction to that CPI report on Tuesday, and maybe to the appointment of Stephen Miran, where we saw a value surge, and we saw small-caps and mid-caps make a lot of ground against large-caps. If we end up where Scott Bessent is right, and the Fed ends up delivering 150 or 175 basis points of cuts, do you think that's the play? Is that the strategy we should be looking for – go down in size, get out of these defensive growth names and into value to play for the rest of this year and into '26.

JACK JANASIEWICZ: Yeah, and maybe just to answer the question straight up, I think that rate cut cycle is the key to unlocking the areas of the market that maybe have been laggards. So to your point, down in cap value, international – that whole segment, I think, could certainly see a pretty significant boost.

The question, though, is that rate cut cycle, will we get the size and the duration of that cut cycle to get to the point where the market's comfortable making that rotation? So going 50 at the September, I think that's probably not happening.

It's just now going to be a question of how many 25s do we get? And is it going to be enough to maybe get that switch to flip to get the next round of that rotation underneath the surface here in that bull market? Certainly, something that we're paying attention to because if I look at something like the Russell 2000, so small-caps, the market is extremely offsides there – huge short base, massively underowned.

If we do start to flip the switch there, that's one area I think we could see a violent rally. It's just a question of we've had plenty of head fakes already. Is three rate cuts enough? Do we need something more? Are we talking – is this a 2026 trade? Remains to be seen, but it's certainly something we're paying attention to.

BRIAN HESS: And it's how much growth slowdown would we have to witness for the Fed to actually go ahead and cut 150 basis points? I mean, Treasury Secretary Bessent is suggesting that the, I think, inflation backdrop alone and the current growth environment is enough for them to cut by that much. But the Fed has certainly had a difference of opinion if you look at the dots, and if you hear what Chairman Powell saying.

So it's that delicate balance of yeah, we want the economy to slow a little bit so we can get contained inflation in these lower rates. But there's a tipping point where uh-oh, now we're in potential recession territory, which small-caps probably not leading in that environment.

JACK JANASIEWICZ: Totally agree.

BRIAN HESS: OK, well we did cover a lot as I thought. So let's leave it there for this month. But great catching up, Jack, and I look forward to seeing how this all plays out.

JACK JANASIEWICZ: Good stuff always.