May Employment Update: Growth Prospects Under Watch; S&P Fairly Valued

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Includes: DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, FWDD, HUSV, IVV, IWL, IWM, JHML, JKD, OTPIX, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWM, RYARX, RYRSX, SCAP, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPSM, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, UWM, VFINX, VOO, VTWO, VV
by: Chris Joseph, CFA
Summary

I updated my economic composite with data from the May BLS employment report released on Friday, June 7.

The gain in nonfarm payroll of 75,000 was short of the consensus forecast of 175,000.

While temp employment was up 5,000 sequentially in May, for an annual rise of 1.5%, growth so far this year has been sluggish.

Uninspiring temp numbers are generating weak scores in the economic composite for later this year.

The valuation model finds the S&P 500 is fairly valued.

Economic Composite

I updated my economic composite to reflect the release of the U.S. Labor Department's employment report on June 7. The report showed a rise in nonfarm employment of 75,000 in May, a considerable miss off the consensus estimate of 175,000. Preliminary numbers for the previous two months were revised slightly downward.

Temp employment in May rose 5,000 from the previous month, climbing 1.5% year over year. As with nonfarm payrolls, preliminary figures for the previous two months were also revised slightly downward.

In the last six months, the number of temps has held about flat. For now, I consider this a not-unusual temporary pause, but the situation bears monitoring.

What’s more, at the end of May, the American Staffing Association (ASA) released its first-quarter data for the temporary employment sector. The report showed that U.S. staffing companies employed an average of 3.07 million temporary and contract workers per week in the quarter, a decline of 1.2% year over year. The number was about 3% short of my estimate.

With the ASA miss and the BLS downward revisions, I’m using slightly more modest forecasts for the BLS temps data series through the end of 2019. I now look for mildly positive sequential increases through December. As a result, the composite starts to flirt with the x-axis later in the year and turns slightly negative in the fourth quarter. The composite is likely to range from -0.5 to 1.0 through the end of the year. It takes three months of a score below zero to signal recession.

For now, I think a recession is unlikely, but the situation requires close monitoring. On a brighter note, the composite is set to turn sharply positive at the start of 2020, as year-over-year comparisons become easier against the sluggishness of this year’s first five months. If the economy can at least muddle through the next few months, it's likely that a slowdown will be avoided. A similar scenario occurred as recently as mid-2016, when the composite flirted with the x-axis and yet the economy continued to grow.

The next Employment Situation report is scheduled to be released on Friday, July 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.

economic forecasting

Valuation Composite

My composite of publicly available forward P/E estimates puts the current forward P/E on the S&P of 2,880 (intraday June 7) at 16.8. With a more solid outlook for the economic composite, I would consider this the low end of fair value. But given the uncertainty toward year’s end, I’m characterizing the current level as fair value.

For more conservative investors, I advise caution in committing new funds to equities. 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.

I prefer to be a more aggressive buyer at a lower P/E, perhaps closer to 15.0, which would equate to roughly 2,600 on the S&P.

A five-year chart of the valuation composite and the S&P 500 is below. The P/E composite is not particularly elevated, but conservative accounts may not like the risk-reward ratio since the economic composite is signaling weakness by year's end.

equity market valuation 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 10% annually.

equity allocation 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.