Seeking Alpha

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

|
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, 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 June BLS employment report released on Friday, July 5.

The gain in nonfarm payroll of 224,000 was well ahead of the consensus forecast of 162,000.

While temp employment was up 4,000 in June, for an annual increase of 1.3%, the trend in temps this year remains about flat.

The sluggish temp numbers, combined with yield curve inversion, 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 July 5. The report showed a rise in nonfarm employment of 224,000 in June. The number was considerably better than the consensus estimate of 175,000. Preliminary numbers for the previous two months were revised downward.

Temp employment in June rose 4,000 from the previous month, rising 1.3% year over year. As with nonfarm payrolls, preliminary figures for the previous two months were also revised downward.

In the last six months, the trend has grown sluggish, with temps declining by an average of 4,000 from month to month. As a result, the number of temps has declined about 1% since December. For now, I consider this a not-unusual temporary pause in growth.

I continue to use very modest forecasts for the BLS temps data series through the end of 2019. I look for mildly positive sequential increases through December. As a result, the composite flirts with the x-axis this summer and turns negative in the fourth quarter. It takes three months of a score below zero to signal recession. The composite is likely to range from 0.5 to -1.0 through the end of the year. If the yield curve remains inverted, the numbers are likely to be slightly worse.

For now, I think a recession is unlikely, but the situation requires close monitoring. Weak temps and yield curve inversion, which preceded the recessions of 1990, 2001, and 2008, are a bad mix. But if the economy muddles through the end of the year, the composite is set to turn positive at the start of 2020, as year-over-year comparison become easier against this year's sluggishness. A similar scenario occurred as recently as mid-2016, when the composite flirted with the x-axis while the economy continued to grow. Likewise, the composite actually turned negative in early 2003, but only for one month. In both cases, though, the yield curve was positively sloped, and not even close to inverting.

The next Employment Situation report is scheduled to be released on Friday, August 2. 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 2,990 (July 5 close) at 17.1. With a more solid outlook for the economic composite, I might 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 S&P has recovered from its December low to make a new 52-week high, while the P/E composite has returned to its mid-2018 levels.

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.