While market concerns remain focused on inflation and recession fears, the incoming data remains consistent with above-trend economic growth, with few odds of a near-term recession.

The data also suggest supply-chain issues are slowly being worked out; wage inflation is down from its recent peak and the participation rate continues to grind higher as the pandemic fades. Importantly, longer-term inflation expectations seem to remain contained, unlike the 1970s inflation period. All of this implies a path exists for a soft landing, which could support further profitability and stock prices.

Economic Readings Remain Healthy

Last week brought us important monthly updates from business surveys and the labor market. These readings are consistent with strong economic growth and support the Federal Reserve’s planned 0.5% interest rate hikes in June and July.

The ISM Manufacturing PMI (a timely survey of business sentiment) increased in May, reflecting an improvement in factory activity during the month, while the level of the PMI remains historically consistent with robust growth in manufacturing output. Growth remained widespread, with 15 of the 18 ISM industries reporting expansion, and only one (furniture & related products) contracting. The breadth of industry expansion also implies continued manufacturing output growth. The ISM Price Index fell 2 points to 82, nearly 10 points below its cycle high in mid-2021, but still consistent with elevated price pressures.

While the ISM Services PMI suggests that services activity has moderated from peak levels earlier in this cycle, it is nonetheless consistent with robust growth. The supplier delivery index fell to its lowest reading since March 2021, indicating less supply-chain stress. The Prices Index also ticked down, as cost pressures eased slightly from a record high in the previous month.

The combined latest readings of the ISM Services and Manufacturing PMIs correspond to about 3% annualized economic growth. For perspective, the economy averaged about 2% growth during last decade’s expansion.

The labor markets remained tight in May. Nonfarm payrolls expanded by 390,000—above the consensus of 328,000. They were up 4.5% y/y, the fastest pace since 1984 (outside of the pandemic), and much faster than what has been seen at the start of all post-WWII recessions except 1953. Such strong payroll growth suggests low odds of recession in the near term. The unemployment rate remained at 3.6% for the third consecutive month, above the consensus of 3.5%, which was the prior cycle trough. The y/y change of average hourly earnings eased to 5.2% from 5.4%, in line with expectations.

Private nonfarm payrolls increased 333,000, the smallest gain in over a year, but still solid from a historical perspective. In comparison, private payrolls had increased an average of 169,000 per month in the year prior to the last recession and had gained an average of 161,000 per month during the previous expansion. The May increase brings private payrolls to just 207,000 below their level in February 2020, as a full jobs recovery is likely only a month away.

Aggregate payrolls—which combine payrolls, hours worked, and earnings—rose 9.6% y/y for all workers. This is more than double the pre-recession pace, which bodes well for personal income and spending growth, and suggests no recession in the near term.

The Market Has Priced in a Significant Economic Slowdown

The stock market performance suggests equity investors have already braced for a slowdown in activity, but not a deep contraction. The nearly 20% drop in the S&P 500 from its peak in January was more modest than the typical recession peak-to-trough decline. The median decline around 12 recessions since WWII equals 24% (implying an S&P 500 level of 3,650) while the average decline equals 30% (S&P 500 level of 3,350). From a valuation perspective, the P/E multiple during a recession typically contracts by 21%. The P/E also contracted 20% in 2022. This suggests investors appear to have priced a meaningful amount of recession risk into U.S. equities.

 


 

Disclaimer

This report is provided for informational and educational purposes only and shall in no event be construed as an offer to sell or a solicitation of an offer to buy any securities or a recommendation for any strategy or to buy, sell, or hold any product. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. Employees of Janney Montgomery Scott LLC or its affiliates may, at times, release written or oral commentary, technical analysis, or trading strategies that differ from the opinions expressed here. The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. The opinions expressed herein may be given only such weight as opinions warrant. This Firm, its officers, directors, employees, or members of their families may have positions in the securities mentioned and may make purchases or sales of such securities from time to time in the open market or otherwise and may sell to or buy from customers such securities on a principal basis. This report is the intellectual property of Janney Montgomery Scott LLC (Janney) and may not be reproduced, distributed, or published by any person for any purpose without Janney’s prior written consent. This presentation has been prepared by Janney Investment Strategy Group (ISG) and is to be used for informational purposes only. In no event should it be construed as a solicitation or offer to purchase or sell a security. Past performance is no guarantee of future performance and future returns are not guaranteed. There are risks associated with investing in stocks such as a loss of original capital or a decrease in the value of your investment. For additional information or questions, please consult with your Financial Advisor.

About the author

For more information about Janney, please see Janney’s Relationship Summary (Form CRS) on www.janney.com/crs which details all material facts about the scope and terms of our relationship with you and any potential conflicts of interest.

To learn about the professional background, business practices, and conduct of FINRA member firms or their financial professionals, visit FINRA’s BrokerCheck website: http://brokercheck.finra.org/