The Big Picture
Oh, no, nonfarm payrolls in May increased more than expected. What's more is that average hourly earnings in May had the audacity to go up more than expected.
How could the May employment report be so insensitive to the market's desire to see the Fed cut rates?
We ask that in jest, but the truth of the matter is that the May employment report has all but killed the chance of a rate cut in July and has brought into question the probability of a rate cut in September.
The May Consumer Price Index (CPI) on June 12 has the potential to alter that calculus, but getting down to brass tacks, the employment situation remains a good situation for the economy -- and that's a good situation for the stock market.
Worth Celebrating
The initial reaction in the Treasury market to the stronger-than-expected May employment report was a textbook reaction. Yields shot higher.
The 2-yr note yield, which is most sensitive to changes in the fed funds rate, jumped 15 basis points to 4.87% while the 10-yr note yield, which is tuned in to inflation pressures, jumped 15 basis points to 4.43%. Those moves unwound a decent portion of prior gains associated with some weaker economic data that created some agitation over the idea that the economy may be slowing more quickly than had been expected.
To that end, the Atlanta Fed GDPNow model estimate for Q2 real GDP growth started at 3.9% on April 26, but fell to 1.8% on June 3 following a weaker-than-expected ISM Manufacturing Index. That estimate bumped up to 2.4% after the stronger-than-expected ISM Non-Manufacturing Index, but now sits at 3.1% in the wake of the May employment report.
If that estimate rings true with the actuals, it will be worth celebrating. In any case, the employment situation is worth celebrating. It may not be a "rager," but it is a lively affair with a feel-good vibe that includes a solid 3-month average 249,000 increase in nonfarm payrolls.
The market way want a rate cut, but what it really needs is a solid labor market because that is the engine that drives spending.
Spending drives the economy, and if the economy is growing, corporate earnings will be growing -- and the market needs earnings growth.
A Happy Medium
The stock market has earnings growth. First quarter earnings were up 6.0%, second quarter earnings are projected to be up 8.9%, and calendar year 2024 earnings are anticipated to increase 11.7%, according to FactSet. The look to calendar year 2025 is even better with earnings expected to be up 14.2%.
There are roughly 18 months between now and the end of calendar year 2025. A lot can and will happen between now and then, not to mention a general election in November 2024 that will determine the occupant of the White House for the next four years and the composition of Congress for the next two years that will be debating and legislating tax policy.
The forward 12-month estimate has been a happy medium as the denominator in P/E calculations and that, too, has been worth celebrating, having risen nearly uninterrupted since January 2023. It stands at $258.13 today, according to FactSet, which leaves the S&P 500 trading at 20.8x earnings.
That is a rich valuation relative to the 10-yr average of 17.8x, which is precisely why the stock market should be cheering a solid labor market. If those earnings estimates are to be met, or exceeded, consumers need to remain gainfully employed and outearning inflation.
In May average hourly earnings were up 4.1% year-over-year. We'll know soon enough where May CPI comes in on a year-over-year basis, but it was up 3.4% in April, whereas the PCE Price Index was up 2.7%.
That is an acceptable trade-off that is supportive of continued spending growth.
What It All Means
Remember there have been 11 rate hikes since March 2022. In the interim, the stock market has hit new highs, inflation has improved (but has more to go), and real GDP growth has averaged 2.7% since the third quarter of 2022 with personal spending growth averaging 2.3%.
The unemployment rate, meanwhile, ranged between 3.4% and 3.9% over the same period before ticking up to 4.0% in the May employment report. We'll keep an eye on that, but the takeaway from the latest employment report is that the employment situation is still a good situation for the economy.
It might forestall a rate cut by the Fed, but only because companies are still hiring, and employees are being paid higher wages that are helping to mitigate the inflation pressures they are still facing.
Ultimately, it is far better to have a job and deal with inflation than is to not have a job and deal with inflation. The situation in the labor market remains conducive for spending growth, which is good for the economy, and good for a stock market sporting a lofty valuation that rests on the continuation of a higher earnings estimate trend.
