June Employment Update: Growth Outlook Confirmed; S&P Fairly Valued

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by: Chris Joseph, CFA
Summary

I updated my economic composite following the release of the June employment report on Friday, July 6.

The gain in nonfarm payroll of 213,000 was ahead of the consensus forecast.

Temp employment increased 9,000 and was up 3.2% year over year.

Fears of a global trade war do not appear to be affecting the pace of hiring. This year’s strength in temps continues to provide support to the economic composite's growth outlook.

The P/E composite suggests fair value on the S&P.

I updated my economic composite to reflect the release of the U.S. Labor Department's employment report on July 6. The report showed a rise in nonfarm employment of 213,000 in June. The number was ahead of expectations. Forecasters were looking for a gain of 190,000, according to Bloomberg News.

Preliminary numbers for the previous two months were revised upward. For the trailing six months, nonfarm employment has grown on average a robust 215,000 per month.

Temp employment in June was up 9,000 from the previous month and increased 3.2% year over year. The preliminary figures for April and May were also revised upward.

For the last six months, temp employment has risen on average a solid 7,000 per month, for an average increase of 3.6%. It's an encouraging sign that employers are seeing enough strength in their business to hire temps at this pace. U.S. employers appear to be shrugging off talk of a trade war between the U.S. and its Asian and European trading partners.

The June 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.

The next Employment Situation report is scheduled to be released on Friday, August 3. 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 the middle of 2020. 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

My composite of publicly available forward P/E estimates puts the current forward P/E on the S&P at Friday's close (July 6) of 2,760 at 18.2. I consider this fair value. The current climate of rising earnings estimates supports a solid outlook for stock prices.

I prefer to be a more aggressive buyer at a lower P/E, perhaps around 17.0, which would equate to roughly 2,600 on the S&P. For now, I would 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 couple of months have been considerably volatile.

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, 2017, 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.