January Employment Update: Growth Outlook On Track; S&P Fairly Valued

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by: Chris Joseph, CFA
Summary

I updated my economic composite following the release of the January employment report on February 2.

The strong gain in nonfarm payroll of 200,000 was ahead of the consensus forecast.

Temp employment was up slightly month to month and up 3.4% year over year. This year’s strength in temps continues to provide support to the economic composite's growth outlook.

Last month, I warned about the historically high level of my composite market P/E and changed my valuation assessment from “fair value” to “high end of fair value”.

After last week’s market decline, I’m more comfortable with the current P/E. I’m returning to a “fair value” assessment.

Economic Composite

I updated my economic composite to reflect the release of the U.S. Labor Department's employment report on February 2. The report showed a rise in nonfarm employment of 200,000 in January. Forecasters were looking for a gain of 175,000, according to Bloomberg News.

With the January report, as it does every year, the BLS provided revisions to its establishment data. This year’s revisions were fairly minor, as they usually are. For example, for the rolling 12 months, nonfarm employment grew on average 176,000 per month. This compares with an average of 171,000 calculated for the twelve months of 2017 using the unrevised data.

Temp employment in January grew 2,000 (+0.1%) from the previous month and climbed 3.4% year over year. This data series was also subject to annual revision. Here again the changes were minor. For the rolling 12 months, temp employment rose on average a solid 8,000 per monthly, compared with 11,000 using 2017’s unrevised data. It's an encouraging sign that employers, in the aggregate, are seeing enough strength in their business to hire temps at this pace.

The January increase in temps was in line with my forecast, so I’m leaving my estimates for the rest of the year unchanged. I continue to look for modest monthly sequential increases in the BLS temps data series, equating to low to mid single-digit annual growth rates. As a result, the composite continues to signal economic growth for the next 12 to 18 months. The composite is likely to range from 1.5 to 2.5 through this year, well into positive territory. I do not expect the economy to tip into recession.

The next Employment Situation report is scheduled to be released on Friday, March 9. I expect to provide an update to the economic composite shortly after the report comes out.

Figure 1 below shows the actual monthly values of the economic composite from 1991 through the present and the estimated values through nearly the end of 2019. In general, the composite remains positive during periods of economic expansion and turns negative during periods of recession. The vertical dashed lines mark the inflection points when the economy is poised to enter recession or has safely exited recession. It typically takes three consecutive months of a change in sign (from positive to negative and vice versa) to confirm a change in outlook.

Valuation Composite

In last month’s update, dated January 6, I noted the historically high level of the composite market P/E. At the time, my composite of publicly available forward P/E estimates was 20.5, the highest it had been in 16 years. I didn’t see much more room for P/E expansion to drive the market higher in the near term. Accordingly, I changed my assessment of the S&P valuation from "fairly valued" to "high end of fair value."

Then the S&P added another 5% to reach a high of 2,873 on January 26, pushing the composite P/E to 20.8, its highest level in 28 years of data.

That was followed by last week’s volatility and a 9% decline off the high. The current forward P/E on the S&P at the Friday close (February 9) of 2,620 is 18.2. This is the lowest reading in over two years. As a result, I’m moving my assessment back from “high end of fair value” to “fair value.”

Still, I prefer to be a more aggressive buyer at a lower P/E, perhaps around 17.0, which would equate to about 2,450 on the S&P. For now, I would still continue to make regularly planned dollar-cost averaging allocations to equities that investors intend to hold for the long term, such as monthly or bi-weekly contributions to a 401(K) plan.

A five-year chart of the valuation composite and the S&P 500 is below. The last two weeks have seen a considerable pullback in the S&P and the P/E composite.

Track Record

The model’s historical record is depicted in the chart below. The economic composite predicted the beginning and end of the 2000 recession and the 2008 recession. It also predicted the end of the early 1990s recession. Some of the data series used in the composite did not exist before 1990; hence, the start of the track record at that time.

In the two historical Overweight periods, the S&P rose 13% and 14% on an annualized basis. In the two historical Underweight periods, the S&P fell 18% and 9% on an annualized basis. In the current Overweight period, the S&P has been returning 11% annually.

Methodology

For a full discussion of the Chartwell method, I refer readers to a description of the process in my April employment update, under the heading “Methodology.”

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.