Encouraged by business surveys, vaccines, and corporate profits

Stocks reached new all-time highs last week with the S&P 500 Index rising 4.6%, the Nasdaq Composite gaining 6%, and the small-cap Russell 2000 jumping 7.7%. Importantly, cyclical sectors that benefit most from the reopening and improving economic conditions continue to show leadership. While the virus remains a near-term headwind for consumer-facing industries, we remain encouraged on the outlook for the economy and markets for several important reasons.

Economic Releases Show Improvement, Despite Virus Headwinds

At the beginning of every month, we get important readings on business sentiment and the labor market that provide signposts for the economy. These readings continue to support our positive view on underlying economic fundamentals, despite virus-induced labor market weakness.

The ISM Non-Manufacturing Index (a timely service sector business survey) increased to the highest level since February 2019, as services activity accelerated at the start of the year. While survey respondents noted that various COVID restrictions continue to weigh on activity, they also expressed optimism about business conditions and the economy. Of the 18 industries in the survey, 14 registered growth, and four contracted. The net number indicates a relatively broad-based expansion. Importantly, the improvement in the overall survey was led by a rebound in the employment index to its highest level since February 2020 while new orders grew at the fastest rate in six months.

The ISM Manufacturing Index (a timely manufacturing sector business survey) remained close to its highest level since November 2018, consistent with continued expansion in manufacturing output and the economy. Of the 18 ISM industries, 16 reported growth, matching the largest share since mid-2018. This breadth of growing industries supports the outlook for continued gains in manufacturing output. The combined service and manufacturing surveys remain consistent with a positive economic outlook.

While Friday’s labor market report showed only modest gains with an increase of 49,000 jobs as the unemployment rate tumbled to 6.3% from 6.7%, there are underlying positive signs in the labor market. Rather than hiring more people, employers worked their existing employees harder, driving the average workweek up by 0.3 hours to 35.0 hours, the longest since the data began in 2006. The longer workweek is equivalent to adding over a million jobs to private payrolls. Meanwhile, initial jobless claims declined for a third straight week, while layoff announcements stabilized. We expect to see improvement in job growth in the coming months, driven by the vaccine-enabled economic reopening that will allow for hiring in the industries hardest hit by the pandemic. This outlook is supported by the positive hiring intentions in the surveys mentioned above.

Positive News on COVID Infection Rate and Vaccines

After the holiday-induced peak in mid-January, the weekly number of new COVID cases has dropped 30% from two weeks ago. In addition, Johnson & Johnson filed for emergency-use authorization for their one-shot vaccine with the promise of providing 100 million doses to the U.S. by the end of June. If approved (coupled with the ongoing rollout of the Pfizer and Moderna vaccines), this would go a long way to solving the current vaccine shortage and allow for herd immunity later this year which will support the reopening of the economy.

Corporate Profits Coming in Better-than-Expected

At the start of the fourth-quarter reporting season, earnings-per-share for the S&P 500 Index was expected to contract by -7.7%. With almost 75% of the market cap having reported, earnings are now on track for +1.9% growth. 74.9% of the S&P 500's market cap have reported results with earnings surpassing estimates by 17.2% in aggregate, with 80% of companies beating their projections. This positive profitability news is important for business confidence, future capital expenditures, and hiring.