The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2021 Midyear Outlook :
- U.S. economy: The growth rate has peaked but will remain high throughout 2021.
- Global economy: The economic recovery will spread to Europe and eventually Asia as more countries achieve herd immunity from COVID-19.
- Policy watch: Policy is becoming marginally less accommodative as the recovery takes hold.
- Fixed income: Even with rates subdued, credit-sensitive parts of the market should lead.
- Equities: The best opportunities may now lie outside the U.S.
- Asset allocation: Continue to allocate toward assets poised to benefit from economic reopening and recovery from the pandemic.
Quote of the week:
"With freedom comes responsibility.”– Eleanor Roosevelt
June jobs data presents a puzzle
Scanning the headlines after the release of June’s payrolls report and you’ll likely read that the U.S. economy added 850,000 jobs last month, topping forecasts for around 710,000, and that totals for April and May were revised up slightly.3 These numbers are based on the “establishment survey,” which asks employers across industries how many workers they’ve hired and let go in the past month. It’s one of two methods the Labor Department uses to determine monthly job growth.
The other is the “household survey,” which polls individuals to measure the labor market status, including the unemployment rate, by demographic characteristics. While these surveys never line up exactly, the divergence between the two was unusually large in June. The household survey showed almost no difference in the number of employed individuals compared to May. And the unemployment rate ticked up from 5.8% to 5.9% despite little change in the size of the labor force.4 Put simply, the 850,000 new jobs reported in the establishment survey were nowhere to be found in the household survey.
Markets tend to rely on the establishment survey, which usually fluctuates less from month to month. So June’s report is considered a net positive in light of the 100,000+ payrolls “beat.” Also, the household survey may have been more challenging than usual to compile given the distortions in seasonality around factors like teen employment (“summer jobs”) and the gradual return to economic normalcy, particularly in service sectors. This year, jobs are returning in droves in these sectors for reasons having less to do with the fact that it’s summer and more to do with the fact that the economy is reopening after a pandemic.
Challenges aside, there are clues scattered throughout both surveys indicating that last month’s report was encouraging on the whole.
- The U-6 underemployment rate fell to 9.8% as far fewer workers reported settling for part-time employment.5 (The U-6 rate encompasses both unemployed workers looking for jobs and part-time employees seeking full-time status.) The U-6 decline makes sense: with workers becoming harder to find, employers are converting more part-time staff to full-time.
- Leisure and hospitality jobs increased by 343,000, while public-sector employment grew by 188,000 — a sign that stimulus money earmarked for state and local governments in the American Rescue Plan Act is being put to use. Despite the June gain, however, government jobs remain down by close to 1 million from their pre-pandemic peak.6
The data for this report was collected too early for us to see much impact from the phasing out of federal enhanced unemployment insurance programs. Those programs — which broaden eligibility for jobless benefits and add $300/week in addition to any state unemployment aid — will expire around Labor Day, although about half of the states will be ending that federal insurance early because some lawmakers believe it discourages lower-paid workers from seeking employment.
But most unemployed workers reside in states that are keeping the programs in place through September, so the full effects of the policy (and its sunset) won’t be known until the October report. That’s a long way away, but in the meantime you’ll hear fewer concerns about overly generous unemployment benefits if job creation stays as strong as it was last month.
Lastly, what does June’s release mean for the Federal Reserve and markets? Not much, in our view. Although adding 850,000 payrolls probably meets the Fed’s definition of “substantial further progress” necessary to keep it on track to taper asset purchases in the first quarter of 2022, the rise in the unemployment rate will give dovish Fed officials ammunition to extend the current zero interest rate policy. This past Friday’s drop in the U.S. dollar and the 2-year Treasury yield (which tends to track Fed policy) indicates that lower rates for longer may be winning out as we enter the third quarter.7
A fine second quarter for diversified investors
We can officially close the book on an outstanding second quarter, one in which nearly all major asset classes provided a positive return. (Note: we’re not including cryptocurrencies in this analysis.) What were some key tailwinds driving the April-June performance?
- Long-term interest rates fell. This was especially noteworthy, particularly in the context of surprisingly high U.S. inflation readings in April and May, and the strongest global economic growth in decades. Under such circumstances, investors would expect long-term U.S. Treasury yields to rise, as they reflect the prospects for GDP and inflation. But that’s not what happened. Bond markets stayed calm during the quarter as the Fed convinced investors that it would ignore those inflation spikes — believing them to be transitory — and remain patient before tightening monetary policy. Against this backdrop, the yield on the bellwether 10-year Treasury note fell 29 basis points during the quarter, from 1.74% to 1.45%. Since bond yields and prices move in opposite directions, that resulted in a 3.1% gain. The 30-year bond (+7.8% return for the period) followed a similar path, with its yield closing at 2.06% on June 30.8
But investors weren’t quite as sanguine as the Fed regarding inflation. Fear of “sticker shock” on consumer goods and services spurred demand for U.S. Treasury Inflation Protected Securities (TIPS). TIPS — designed to provide a hedge against inflation by adjusting their face amount by the percentage rise in the Consumer Price Index — gained 3.2% in the second quarter, making them one of the top-performing fixed-income asset classes for the period.9
- Credit spreads compressed. Low volatility in fixed-income markets reminiscent of pre-COVID-19 days supported solidly positive returns for spread sectors and other higher-yielding assets, including investment grade (+3.5%) and high-yield (+2.7%) corporate bonds, and emerging market debt (+3% in U.S. dollar terms.)10 (Spreads are the difference in yield between U.S. Treasuries and a lower-quality bond of the same maturity.) These higher-yielding sectors benefited from (1) the global search for income given low or even negative yields paid by government bonds worldwide; (2) investor confidence in a strengthening global economy, accompanied by low default rates and (3) a commitment by major central banks to maintain dovish monetary policy, which kept corporate borrowing costs down.
- Corporate earnings surged. According to Bloomberg, 87% of S&P 500 Index companies reported a positive earnings surprise during the quarter, the best result in almost 30 years, and 74% a positive revenue surprise, a near record high.11 This not only helped drive stock market performance, but it also made stocks more attractive from a valuation perspective. Using a common metric like the price-to-earnings (P/E) ratio, if the “E” rises more than the “P,” valuations will fall. And that’s precisely what happened during the second quarter. In the case of the S&P 500, which posted a healthy 8.6% return, its P/E ratio dipped from 22.1 to 21.4, as its E more than offset its P.12 Likewise, the MSCI All-Country World Index, which tracks large- and mid-cap stocks across developed and emerging markets, gained 7.7% in U.S. dollar terms but became less expensive on a P/E basis (from 19.5 to 18.7) thanks to blowout earnings generated by companies around the globe.13
As we stated in our midyear outlook, the second quarter’s broadly bullish performance across asset classes isn’t likely to last much longer. But by rebalancing their portfolios, investors can use the larger-than-anticipated gains from the first and second quarters of 2021 to start building asset allocations that will endure through a period of lower returns over the balance of 2021 and, we think, the better part of this decade.
Read more about our investment views in Nuveen’s Midyear Outlook, “Growth is peaking. What comes next?”