Seeking Alpha

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

|
Includes: BAPR, BAUG, BIBL, BJUL, BJUN, BOCT, CHGX, CRF, DDM, DIA, DMRL, DOG, DUSA, DXD, EDOW, EEH, EPS, EQL, EQWL, ESGL, FEX, FWDD, GSEW, HUSV, IVV, IWL, IWM, JHML, JKD, OMFS, OTPIX, PAPR, PAUG, PJAN, PJUN, PMOM, PPLC, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RVRS, RWL, RWM, RWSL, RYARX, RYRSX, SCAP, SCHX, SDOW, SDS, SFLA, SFY, SH, SMLL, SPDN, SPLX, SPSM, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, SSPY, SYE, TNA, TQQQ, TRND, TWM, TZA, UAUG, UDOW, UDPIX, UJAN, UOCT, UPRO, URTY, USA, USMC, UWM, VFINX, VOO, VTWO, VV, ZF
by: Chris Joseph, CFA
Chris Joseph, CFA
Long only, CFA, newsletter provider, research analyst
Summary

I updated my economic composite with data from the December BLS employment report released on Friday, January 10.

The gain in nonfarm payroll of 145,000 was a little short of the consensus forecast of 160,000.

Temp employment was up 6,000 on a month-to-month basis. Annually, temps were off slightly, by 0.5%.

A sluggish near-term outlook for temp numbers is generating mildly weak scores in the economic composite, putting growth prospects under watch.

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 January 10. The report showed a rise in nonfarm employment of 145,000 in December. The number was a little light of the consensus estimate of 160,000.

Temp employment in December rose a decent 6,000 from the previous month. On an annual basis, temps fell half a percent.

This marked the second consecutive month of solid improvement in the monthly change in temps (up 4,000 in November). For all of 2019, the average monthly change was a loss of 1,000 temps. But the yearly average masks a positive turn in temps in the second half. For the first six months of the year, temps were declining by 5,000 per month. But in the second half, the average change was a gain of 2,000. I'm hopeful the positive trend will continue into 2020.

Since my last report in October, the American Staffing Association also released its latest quarterly data. On December 5, the ASA reported that U.S. staffing companies employed an average of 3.07 million temp workers per week in the third quarter. This was a little short of my estimate of 3.11 million. On an annual basis, the number was off 4.7%. The ASA data series has been weak for all of 2019, declining 1% and 3% in the first and second quarters. I expect the trend persisted in the final quarter and is likely to continue this year, falling at rates in the mid single-digit percentages. This will put downward pressure on the monthly economic composite scores.

Also, since my October 7 report, last summer's yield curve inversion came to an end. The model includes a factor for the shape of the yield curve, so the end of inversion is a positive for scores. My estimates had already assumed a positively-sloped curve before the end of 2019, as I noted in my October report.

As a result of the sluggishness in the monthly BLS data and the quarterly ASA data, the economic composite has been negative since June 2019. This would normally signal an impending economic slowdown; however, the monthly readings so far have been mild, generally tracking close to the x-axis and reaching as low as 1.6.

My estimates for the number of temps for the next six months are very modest. I also assume the yield curve remains positively sloped. The effect is slightly negative economic composite scores through the first half of the year, at around -1.0.

For now, the trend suggests year-over-year temp comparisons will grow easier in the second half of the year, helping to push the economic composite up. In the next 12 months, the composite ranges from -1.0 to +1.0. A similar scenario occurred as recently as mid-2016, when the composite flirted with the x-axis while the economy continued to grow.

I think a recession is unlikely, but the situation requires close monitoring. An unusually weak month or two for temps could raise the possibility of a slowdown.

The next Employment Situation report is scheduled to be released on Friday, February 7. 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 3,265 (January 10 close) at 18.4. I characterize the current level as fair value, especially given the current uncertain economic outlook. If a recession is imminent, earnings estimates will fall, and the market P/E will decline as investors turn against equities. The combination of declining earnings estimates and a falling market P/E would be a considerable drag on the S&P.

For more conservative investors, I advise caution in committing new funds to equities. I would consider adjusting 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, to a 50/50 mix of cash and equities.

I prefer to be a more aggressive buyer at a lower P/E, perhaps closer to 16.0, which would equate to roughly 2,800 on the S&P.

A five-year chart of the valuation composite and the S&P 500 is below. In the last three months, the S&P and the P/E composite have climbed considerably, up 9% and 10%.

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 11% 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.