Stocks made new highs again last week and we remain optimistic about the outlook for the economy and financial markets.
While the surge of the Delta variant has had a noticeable impact on consumer confidence, employment, and economic activity, there are early signs that it is cresting. Delta concerns were a key reason for the underperformance of consumer services and cyclical stocks over the summer. We expect these groups to benefit as concerns about Delta subside.
While Friday’s job report was disappointing, many other indicators are pointing to further labor market gains in the months ahead, which we see supporting sustainable economic growth.
Business Surveys Continue to Paint a Positive Picture: The ISM Services PMI, a timely business survey, slipped from its recent high, suggesting some moderation in services activity growth. However, the index is still close to historic highs, while its six-month average hit a new all-time high, consistent with a broad-based, strong expansion. Indeed, of the 18 ISM services industries, 17 reported growth and only one (Arts/entertainment/recreation) contracted. A broad range of inputs, including labor, continued to be reported in short supply and up in price. Nevertheless, the services Prices Index indicated some moderation in cost pressures.
The ISM Manufacturing PMI edged up in August. While off its peak reached in March of this year, the PMI is close to its highest level in three years, indicating a robust pace of factory activity growth. This level of the index is historically consistent with both continued above-trend manufacturing output growth and a continued broad economic expansion.
Individual activity indexes painted a mixed-to-positive picture. Production and new order growth, as well as export orders, accelerated, a sign of strengthening demand. But employment fell back into contraction territory, mostly reflecting labor shortages and recruiting difficulties, per respondents’ comments. Partly due to this, order backlogs picked up to a near-record rate. Respondents continued to view their customers’ inventories as extremely low, although that indicator is now off its rock bottom level. The inventory indexes suggest that some stock rebuilding has begun, which bodes well for future demand and production.
The latest ISM Manufacturing and Services PMIs are consistent with about 4.5% annualized economic growth, which is about double the pre-pandemic pace.
Disappointing August Employment Report: Nonfarm payrolls expanded by just 235,000, the smallest rise in seven months, and well below the consensus estimate of 720,000. The prior two months, however, were revised up by a large 134,000, somewhat lessening the sting of the disappointing miss. The unemployment rate declined to 5.2% from 5.4%.
Private payrolls increased 243,000, the smallest gain since April, with a broad-based deceleration across industries. Notably, leisure and hospitality jobs were unchanged, after rising an average of 350,000 over the prior six months. This suggests an impact from the Delta variant spread, which has paused the jobs recovery in this industry. Retail trade, another client-facing industry impacted by the Delta variant, cut 29,000 jobs, down for the second consecutive month and by the most since the lockdown last year. In contrast, transportation and warehousing jobs increased by 53,000. Over the past three months, job growth in that industry has averaged 44,000 per month, the most this year, reflecting growing demand for workers in freight and e-commerce.
While the August employment report was disappointing, we remain positive on the outlook for the labor market. Initial unemployment claims are now at a new pandemic low, falling 14,000 to 340,000 last week. Continuing claims and the insured jobless rate are also at the lowest levels since March 2020. There are currently 10 million job openings, which is 2.5 million higher than the pre-pandemic peak. We expect these job openings to lead to significant hiring in the coming months that should allow for a further successful handoff from government support to the private sector – providing the pathway to a sustainable economic expansion and further stock gains.
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