06.10.19

June swoon? No sign of one last week.

Brian Nick

The last week’s market highlights:

Quote of the week:

“Poor Mexico. So far from heaven, so close to the United States.”– Porfirio Díaz (7-term president of Mexico)
 
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2Q 2019 Outlook :
 
  • U.S. economy: Late cycle but no recession
  • Global economy: Slower this year than last  
  • Policy watch: A dovish turn for global central banks  
  • Fixed income: Rates likelier to rise than fall
  • Equities: Get defensive, stay invested
  • Asset allocation: Still favorable to emerging-market assets

U.S. economy:  Aspiring to be Australia?   

Markets have had plenty to fret about over the past few weeks. But it wasn’t so long ago—10 years, to be exact—that things were far worse in the U.S. Consider that in June 2009:
  • General Motors filed for bankruptcy just one month after Chrysler had done the same.
  • Warren Buffet echoed his grim outlook from Berkshire Hathaway’s 2008 annual report, stating that, “The economy (will) be in a shambles this year and probably well beyond.”
  • Employers cut 424,000 jobs, the 17th straight month of shrinking payrolls. That June decline brought total job losses since the beginning of the recession in December 2007 to more than 7.5 million.
 
In an attempt to find a glimmer of hope amid the barrage of bad news, the Obama White House pointed to a slower pace of job declines. “We’re seeing a kind of leveling off,” said then-labor secretary Hilda Solis.
 
Indeed, there were brighter days ahead. Since the Great Recession officially ended in June 2009, the U.S. economy has successfully avoided two consecutive quarters of negative GDP growth (the technical definition of a recession). Next month will mark the nation’s longest expansion ever, overtaking the one that spanned the 1991-2001 technology boom.
 
Overall, U.S. recessions have become milder and less frequent. Prior to 1980, they occurred roughly every 2-4 years. What’s changed in the economy since then? Manufacturing now represents a smaller share of U.S. GDP—just 12%, down from about 20% in 1980. Meanwhile, the nonmanufacturing, or service, sector has become more dominant. This sector is less cyclical and more stable, with companies that are less likely to lay off workers when the U.S. hits a soft patch.
 
We believe the U.S. economy remains in good shape in part because of the ongoing strength of its service companies. In May, the Institute for Supply Management’s (ISM) non-manufacturing Purchasing Managers’ Index (PMI) beat expectations by rising to 56.9, well above the 50 mark separating growth from contraction. In contrast, ISM’s manufacturing PMI fell to a 2½-year low of 52.1. This below-forecast result comes on the heels of other signs of weakness in manufacturing, including April’s disappointing results for durable goods, factory orders and “core” capital goods, a measure of business investment.   
 
Other major economies are more susceptible than the U.S. to a manufacturing slump. In Germany, for example, the sector makes up about 20% of the economy. With that country’s manufacturing PMIs stuck in contraction territory, overall business sentiment has plunged. Not surprisingly, the German economy continued to struggle in the first quarter, registering just 0.4% GDP growth.  
 
Another demonstration of the U.S. economy’s resilience is its ability to weather oil shocks better than other major oil-producing nations. As the West Texas Intermediate oil price benchmark fell sharply from $104/barrel in July 2014 to below $60 for much of 2015-2016, U.S. GDP growth slowed but stayed positive. Brazil’s economy began to shrink on a year-on-year basis starting in the second quarter of 2014 and did not emerge from recession until early 2017. Russian GDP growth turned negative in the first quarter of 2015 and took five quarters to turn around.
 
Last November, Federal Reserve Chair Jerome Powell quipped that “business cycles don’t last forever, I guess, unless you’re Australia.” (That’s because the last recession Down Under took place in 1988.) As for the U.S., despite May’s underwhelming jobs report, we don’t believe a recession is imminent. And while the U.S. cycle is likely in its late stages, the economy may keep on growing for a while longer, perhaps through 2020.      

The May jobs report: Don’t worry. Be (kind of) happy.    

While lackluster, May’s employment report contained less evidence of a significant weakening in the labor market than the headline number suggests. The U.S. economy added just 75,000 jobs last month compared to consensus expectations of 180,000. To make matters worse, March and April payrolls were revised down by a total of 75,000, meaning job growth was essentially zero. Moreover, wage growth (+0.2%) came in a tick lower than expected in May and decelerated on a year-ago basis (+3.1%, versus 3.2% in April). 
 
So where’s the good news?
 
The labor force participation rate stayed steady (62.8%), and U-6 “underemployment” ticked down to 7.1%, the lowest level since 2000. The U-6 rate, which encompasses both unemployed workers looking for jobs and part-time employees seeking full-time work, is a better measure of labor market slack than the headline unemployment rate, which remained at 3.6% in May. With job openings plentiful, the flow of new workers should lift job creation over the next few months—but probably below the 200,000 monthly average we’ve seen since last June. Adding even 150,000 or so workers each month would be more than acceptable at this stage of the economic cycle.
 
It’s worth noting that employment data is no longer uniformly positive. Last week, payroll processor ADP reported that companies added just 27,000 positions last month. Additionally, according to global outplacement firm Challenger, Gray & Christmas, U.S.-based employers announced plans to cut nearly 60,000 jobs in May, up substantially from April and a year ago.
 
At the same time, initial unemployment claims, a good leading indicator for other labor data and the economy as a whole, remain near multi-decade lows. And the dip in inflation amid slow-but-steady wage growth is raising real take-home pay, which should also support the economic expansion.
 
How will markets respond to May’s weak job creation numbers? Friday’s jubilant rise in U.S. equity markets following the release of the payrolls report provides a strong clue. To what extent that initial rally proves sustainable may depend on the Fed’s next move, which makes the June 19 meeting required watching. At this point, we don’t believe economic conditions warrant a 2019 rate cut—but markets seem to disagree.
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
 
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