August jobs data
In August, the economy added only 235,000 jobs, and the unemployment rate fell to 5.2 percent from 5.4 percent. According to Dow Jones, economists expected 720,000 new jobs in August. The 0.6 percent increase in average hourly wages was also unexpected, coming in at twice the expected rate.
Some experts predicted that a strong report, like the one in July, would push the Fed to announce in September that it would begin slowing its $120 billion monthly bond purchases. The total number of payrolls in July was revised higher to 1.05 million, up from the original estimate of 943,000.
“Even with the upward revisions, this is a gut-wrenching number, and the imprint of delta is all over it,” said Diane Swonk, Grant Thornton’s chief economist. Economists predicted significant gains in leisure, hospitality, and education, but these did not materialize. “It is critical to understand that we cannot sustain demand if we cannot contain the virus.”
The report highlights two concerns about the economy: a potential slowing while inflation continues to rise.
Strategists believe the August report will put the Fed on a slower path to exiting its easy policy than some market experts anticipated. The market has been splintered. Some strategists and economists predicted that the Fed would make an announcement in September if the job market was strong, while others predicted an announcement in November or December.
“It makes September 22 look a lot less likely,” said Michael Schumacher, Wells Fargo’s director of rates. Stocks fell as a result of the report, while Treasury yields rose. He explained that the 10-year yield increased to 1.33 percent, up from 1.29 percent before the announcement, in response to inflationary concerns.
“Wages increased significantly. “It makes me wonder if this big swing in inflation is just a passing fad,” Schumacher said. Annually, average hourly wages increased by 4.3 percent. “Wage inflation is especially difficult because it is sticky.”
According to strategists, August’s employment figures are frequently volatile and subject to revision, but Covid clearly had an impact on this report.
“The biggest offender was leisure and hospitality, which was flat in August after being 415,000 in July,” Schumacher said. Mobility data revealed a slowdown in hotspots, and credit card activity revealed lower spending.
Expectations for a November announcement from the Fed have risen after Fed Chairman Jerome Powell stated last week that he would like to see more progress on the jobs front.
“Powell keeps mentioning the pre-Covid job deficit. “It will take time to chip away at that,” Schumacher explained. Nonfarm employment has increased by 17 million since April 2020, but it remains 5.3 million lower than the pre-pandemic level in February 2020.
Private education added 40,000 jobs, while state government education lost 21,000 and local government education lost 6,000. The drop comes after big gains in June and July.
The taper would be the first step toward undoing the Fed’s easy policies enacted to combat the pandemic. According to Swonk, Powell has gone out of his way to emphasize that the Fed’s actions on the bond program will not automatically result in a move toward higher interest rates.
Once the bond program begins, the Fed is expected to take months to wind it down.
“From the Fed’s perspective,” she explained, “they are really attempting to decouple the idea of tapering from the idea of liftoff,” or interest rate hikes. As a result, the Fed is still likely to talk about the parameters it would look for before beginning the taper, while emphasizing that it was a program designed to help financial markets during the height of the crisis.
“They already stated that they require a couple of good months, such as July and June, and we did not receive them. This slows things down a little, but I believe they’ll do something by the end of the year. This pushed it out a little,” Swonk explained.
Earnings season lesson
According to FactSet’s John Butters, 87 percent of S&P 500 companies beat earnings per share estimates, the highest level on record since FactSet began tracking the figure in 2008. Earnings growth in the index’s major companies was 91 percent year on year.
Large margins, broad strength
Expectations were high going in, but the breadth of the earnings beats was surprising, according to Sanctuary Wealth’s chief investment officer, Jeff Kilburg.
“I believe people expected a more bifurcated earnings season, and I believe overall I was more impressed with earnings season. And I believe this is reflected in all-time highs across all indices,” Kilburg said.
Revenue growth was expected to be strong, but margins were a big surprise, according to Stephanie Link, chief investment strategist and portfolio manager at Hightower Advisors. In the second quarter, key commodity prices rose, and there were more reports of supply chain issues and difficulty hiring workers.
“I think how companies handled higher commodity prices, higher wage pressures, was impressive,” Link said, adding that the free cash flow generated during the quarter was “absolutely huge.”
According to Victoria Fernandez, chief market strategist at Crossmark Global Investments, expanding profit margins will help to alleviate concerns about “peak everything” that weighed on the market this summer.
“Even though those growth numbers will be lower in the third and fourth quarters, I still believe we will have positive growth, the fundamentals will be strong, and the equity markets will continue to rise… “I really believe that earnings growth will drive a lot of the market optimism,” Fernandez said.
On a sector level, Link stated that financials were a group that stood out positively to her, whereas Kilburg stated that corporate reports and external news were bullish for cybersecurity stocks.
“What we realized during this earnings season is that there is a growing need for it. The global intensity of these cyberattacks will continue to drive up costs, according to Kilburg.
In addition to quarterly results, earnings reports allow companies to revise their forecasts for future quarters. According to FactSet, 67 S&P 500 companies reported positive earnings guidance in the second quarter, the highest number since 2006.
According to Randy Frederick, managing director of trading and derivatives at the Schwab Center for Financial Research, guidance appeared to play a larger-than-usual role in how stocks traded after earnings reports this earnings season.
“Those who have exceeded their targets have risen slightly. Those who guided flat or lower were severely punished,” Frederick explained.
Frederick predicted that guidance would be a key metric again during third-quarter earnings, as investors want to know how management views the potential length of the pandemic and supply chain issues.
Some companies declined to provide much or any guidance, citing the pandemic’s uncertainty. According to Crossmark’s Fernandez, companies may be remaining particularly cautious, paving the way for another round of earnings beats in the third quarter.
“We’ve had a lot of companies come out and kind of downplay third-quarter earnings, saying we’re still concerned about the supply chain, chip shortages, and all of these things that are affecting so much in the economy. So I’m wondering if they’re lowering the bar on purpose,” Fernandez said.
However, even strong earnings results and an optimistic outlook do not guarantee that the market will rise. According to Frederick of Schwab, the end of some stimulus programs, such as enhanced unemployment benefits, could lead to less aggressive market dip-buying.
Furthermore, Phillip Toews, CEO and portfolio manager at Toews Asset Management, stated that the strong results were insufficient to make him concerned about the market’s valuation, specifically the trailing price-to-earnings ratio.
“Almost everything in the equity market is noise in terms of predictive power for us as risk managers,” Toews said. “And the only times we’ve been at or above 28 [trailing P/E] were in the run-up to the internet bubble and briefly when earnings were crushed during the financial crisis.”
Toews described his outlook as a “boom-boom-kaboomer,” implying that a significant market pullback is likely, even if it does not occur soon.