August brought new highs to U.S. equity indexes, with the S&P 500 enjoying its seventh straight month of positive performance despite concerns about inflation, labor markets, and the pandemic.
Large companies performed very well in the second quarter: for the 98% of S&P 500 companies that have already reported second quarter earnings, earnings growth was a blinding 89%, far outstripping the expected earnings growth of 63%.
There are a few areas that could weigh on markets going forward, namely the pace of the recovery and the impact of Federal Reserve policy, but through August at least, markets have pushed through such concerns with fairly strong momentum.
Employment was expected to grow by 725,000 jobs in August. In fact, the U.S. economy added just 235,000 jobs in August, sharply below expectations and the 1.1 million jobs created in July.
Economists have identified a number of potential reasons for the dip, including the spread of the highly contagious Delta variant of COVID-19,enhanced unemployment benefits, childcare issues, and others. That said, the unemployment rate fell slightly, to 5.2%, and wages rose 0.6% from July for an annual increase of 4.3% through August. Part of this was driven by job losses in low-wage sectors such as leisure and hospitality, while a lack of available workers has also helped boost wages.
One logical question here is, of course, what’s the goal?
A common turn of phrase in market and economic news these days is that the Federal Reserve is looking for “full” or “maximum” employment. This is essentially an unemployment rate that’s consistent with a steady inflation rate (in other words, not a literal maximum).
A simple way to think about this is that full employment is achieved when the economy is running “hot” enough that wages and prices are rising steadily— wages because businesses need workers and prices because workers have money to spend. Hotter than this and inflation gets too high, cooler than this and we haven’t achieved employment potential.
In practice, it’s difficult to define the point at which we’ve achieved full employment, especially in the wake of COVID-19, which upended the labormarket. The Fed has also updated its models of the relationship between employment and inflation after determining that it may have raised interest rates too early after the last recession.
Some Fed officials believe the U.S. economy may achieve full employment as early as next year, especially if workers return to jobs after the start of the academic year. That said, we may see longer term shifts in the characteristics of the labor market, which also impacts policy and of course economic growth.
With all the economic data points to consider, the continued uncertainty around COVID-19 variants and global travel and recovery, it can be difficult to gauge where we are exactly. For investors, one interesting data point is the recovery of the corporate sector.
A Wall Street Journal analysis found that over 75% of the largest U.S. companies have reported higher revenue than before the pandemic—an indication that they may have already adapted and bounced back. Of course, this varies by sector, with areas such as consumer services, airlines, and of course tourism still feeling the impact of the pandemic. That said, about a third of companies in the S&P 500 have seen continued growth through the pandemic and recovery period.
While large-cap firms are certainly far from the only employers in the economy, the robust recovery here does provide some optimism for recovery in jobs. Interestingly, many large employers have moved to raise their minimum wages, with average pay for supermarket and restaurant workers reaching $15 per hour.
Of course, this has spurred some level of inflation concern. While there are policy complexities to consider, as noted above, Fed Chair Jerome Powell reiterated recently that the Fed “remains steadfast in our oft-expressed commitment to support the economy for as long as is needed to achieve a full recovery.”
Markets have performed very well through summer. As we head into the fall there are still risks on the horizon, but overall the economic picture is one of general recovery, with plenty of policy support. While the potential for volatility remains, the strong performance of large corporations seems to indicate a degree of robustness. The jobs situation is one that the Fed is certainly keeping an eye on, and which will continue to evolve with the end of enhanced unemployment and a return to the normal school year.
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