I updated my economic composite to reflect the release of the U.S. Labor Department's employment report on March 9. The report showed a rise in nonfarm employment of 313,000 in February. Forecasters were looking for a gain of 205,000, according to Bloomberg News.
Preliminary numbers for the previous two months were revised slightly upward. For the trailing six months, nonfarm employment has grown on average a robust 205,000 per month.
Temp employment in February added 27,000 (+0.9%) from the previous month and climbed 4.2% year over year. The preliminary figures for January and December were essentially unchanged.
For the last six months, temp employment rose on average a solid 10,000 per monthly, for an average increase of 4%. It's an encouraging sign that employers are seeing enough strength in their business to hire temps at this pace.
The February increase in temps was ahead of my forecast, providing more confidence in my estimates. I’m leaving my forecasts 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.
Next month will mark eight years that the model has been continuously forecasting U.S. economic expansion. The inflection point came in March, 2010, when the composite score remained above zero for three months. This was about nine months after the NBER's classification of the end of the Great Recession and a year after the S&P hit its low of 667. In that time, the S&P has averaged an annual return of about 11.5%.
There were several dark periods in those eight years, when many market-watchers were predicting a double-dip recession: the euro crisis in the summer of 2010, the U.S. debt crisis in the fall of 2011, the sequester crisis in the fall of 2012. As an example, in September 2011, the Economic Cycle Research Institute (ECRI) alerted its clients of an upcoming recession. The recession never materialized, and it took ECRI several years to walk back its call.
All these events proved to be good buying opportunities. The economic composite was well above zero during these periods, and the composite inputs were all trending favorably. At the same time, the accompanying market declines pushed my P/E composite to levels suggesting the S&P was favorably priced. These were classic examples of the Wall Street expression, "The market has predicted 10 of the last 5 recessions."
The next Employment Situation report is scheduled to be released on Friday, April 6. 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.
In last month’s update, dated February 12, the market had just come off about two weeks of a correction, in which the S&P declined 10% from its high. My composite P/E fell from its highest level in 28 years to its lowest level in two years, from 20.8 to 18.2. I changed my assessment of the market from “high end of fair value” to “fair value.“
Since then, the S&P has rebounded 5%. Currently, the current forward P/E on the S&P of 2,757 (mid-day March 9) is 19.1. I continue to view this as “fair value,” given the current climate of rising earnings estimates.
S&P earnings continue to come in strong. As FactSet noted in its latest “Earnings Insight” report dated March 2, with 97% of the companies in the S&P 500 reporting results for 4Q17, 74% of those companies beat the mean EPS estimate. Earnings beats generally lead to higher forward earnings estimates, which push down forward P/Es.
I prefer to be a more aggressive buyer at a lower P/E, perhaps around 17.0, which would equate to about 2,500 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 few weeks have shown some stabilization off the correction.
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.
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.”