August Employment Update: Expansion On Track; S&P Fairly Valued

by: Chris Joseph, CFA


I updated my economic composite following the release of the August employment numbers last week, on Friday, September 7.

The gain in nonfarm payroll of 201,000 exceeded the consensus forecast of 190,000.

Temp employment was up 10,000, for an annual increase of 2.9%.

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.

Economic Composite

I updated my economic composite to reflect the release of the U.S. Labor Department's employment report last week on September 7. The report showed a rise in nonfarm employment of 201,000 in August. 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 little changed. For the trailing six months, nonfarm employment has grown on average a robust 192,000 per month.

Temp employment in August was up 10,000 from the previous month and increased 2.9% year over year. Preliminary figures were revised downward.

For the last six months, temp employment has risen on average a solid 5,000 per month, for an average increase of 3.3%. It's an encouraging sign that employers are seeing enough strength in their business to hire temps at this pace. As I first noted in early April, they appear to be shrugging off concerns about rising tensions over international trade.

The August increase in temps was ahead of my forecast of 10,000, providing more confidence in my estimates. I’m leaving my forecasts for the rest of the year and into 2019 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 the middle of next 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, October 5. 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 (September 7) of 2,872 at 18.0. I consider this fair value. The current climate of rising earnings estimates supports a solid outlook for stock prices.

S&P earnings continue to come in strong. As FactSet noted in its most recent “Earnings Insight” report dated September 7, with nearly all of the companies in the S&P 500 reporting results for 2Q18, 80% of those companies reported a positive earnings surprise. Earnings beats tend to cause analysts to raise their forward earnings estimates, which lowers forward P/Es.

I prefer to be a more aggressive buyer at a lower P/E, perhaps around 17.0, which would equate to roughly 2,700 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. While the S&P has climbed about 4% so far this year, the P/E composite has declined 10%, reflecting the increase in the earnings estimate for the index.

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.


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.