The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2021 Outlook:
- U.S. economy: Getting worse before it improves.
- Global economy: Ready to get back to normal—with the help of vaccines.
- Policy watch: No Federal Reserve interest-rate hikes until at least 2023.
- Fixed income: A modest-risk overweight with a focus on credit sectors.
- Equities: Lean toward small caps, emerging market shares and dividend payers.
- Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.
Quote of the week:
"Follow the money.” – Hal Holbrook
For the U.S. job market, a less-than-stellar start to the year
January’s U.S. employment report wasn’t all bad, just mostly bad. On the admittedly scant plus side, net payroll changes turned positive, with employers adding 49,000 jobs after shedding more than a quarter of a million of them in December.2 And the headline unemployment rate declined to 6.3%, versus expectations it would stay at 6.7%.3
Those surface improvements mask some very troubling details elsewhere in the report:
- Payrolls for the prior two months were revised downward by a combined 159,000. (November’s job gains decreased by 72,000, and December’s losses grew by 87,000.)4
- The labor force shrank by 406,000, perhaps in part because many workers had to care for family members.5 Alternatively, this decline may simply be a statistical quirk. The report shows the number of unemployed workers actually fell by 606,000, which we believe is unlikely.6
Economists at the Bureau of Labor Statistics, which issues the jobs report, are struggling to account for large seasonal adjustments that typically occur in January as temporary holiday workers leave their jobs. Complicating matters is COVID-19’s unprecedented shock to the labor market. Bottom line: it’s hard to find “good” reasons why the unemployment rate fell to 6.3% from 6.7% in December. The only explanations we have are bad (people dropped out of the labor force) or neutral (the data is wrong).
Another detail that’s difficult to interpret is that wage growth was slightly below forecasts. We have observed average wage growth increasing over the past year, a sign that low-paying jobs are being disproportionately eliminated by the pandemic. It’s possible wage growth will actually plummet once the pandemic ends and more lower-wage jobs become available.
If it weren’t obvious already, the coronavirus remains the primary determinant of the health of the labor market. Jobs that could return amid the COVID-19 crisis have done so, and those that cannot, have not. The burst of job creation we saw from last May to November (more than 12.6 million payrolls added) was the low-hanging fruit. Getting back the 9.9 million jobs still missing will require a fuller return to normalcy on the part of businesses, consumers and governments.7 Nearly 40% of unemployed workers have been without a job for six months or more, a number that continues to rise each month.8
Setting January’s jobs report aside for a moment, the U.S. labor market news over the past several weeks has been mostly positive. The environment is friendlier to job creation than it was just a month ago based on the recent decline we’ve seen in initial and continuing jobless claims. Moreover, relief payments are working their way through the economy and new virus cases are falling quickly, as well over 1 million Americans are vaccinated each day. Lastly, January business sentiment readings were strong, especially in the services sector, where employment tends to ebb and flow along with the COVID-19 numbers.9
Looking only at the silver lining of the past month’s cloudy jobs data suggests that the ongoing employment crisis has probably stopped getting worse for now. As an added bonus, if you will, we believe the January report supports the argument that further government aid is still needed. Indeed, there’s a $1.9 trillion hole in the Senate budget agreement ready to be filled with new-and-improved pain relief and more stimulus for the economy.
Our view on valuations
The “meme stock” fad, which saw large numbers of retail investors bid up small cap stocks like GameStop and AMC in order to “squeeze” short sellers of those companies, mostly receded from headlines last week. This phenomenon proved relatively short-lived but fueled increased volatility that inflicted sharp losses for some who entered the fray without much experience in trading and market timing.
Although the small bubbles that formed and quickly burst during the meme market are no longer making news, the experience has raised questions about the valuation of the broad equity market.
Why worry about valuations? Of particular concern is whether and to what extent stock prices have risen beyond levels justified by their underlying company fundamentals, most notably earnings growth. The S&P 500 Index gained an average of 7.5% per year and rose in 16 out of the last 20 years following the bursting of the dot.com bubble beginning in 2000.10 Last year’s earnings plunge, coupled with the 18% total return for the index, pushed the S&P 500’s price-to-earnings (P/E) ratio to 22.3 as of February 5, above its long-term average of 16.3.11 Investors may be getting anxious that a pullback is in the offing, one that — unlike the precipitous downturn of last February and March — probably won’t be followed by a roaring bull market.
But circumstances are much different today than they were during the stock market’s remarkable mid-90s to early 2000 run. Valuations toward the tail end of that stretch reflected hope for the eventual profitability of many new companies.
In comparison, valuations today signal that the market expects many businesses will merely return to the status quo ante once the pandemic passes. Moreover, an imminent collapse in equity prices seems unlikely under the current circumstances, absent a complete failure to contain and reverse the public health crisis. Even then, as we learned last year, the drop in the market might only be temporary.
The relative value story is another important difference between today’s environment and that of the technology bubble. In 2000, stocks looked incredibly expensive compared to bonds (and cash). That’s not the case today. The equity risk premium currently offered by U.S. large caps is still well above the historical norm compared to major segments of the fixed-income market, including U.S. Treasuries and corporate credit, both investment grade and high yield. In our view, investors are being adequately compensated for taking on additional risk versus those more conservative asset classes.
Of course, absolute returns matter, too. From 2016 to 2020, the S&P 500 has delivered an average annual return of 15.2%.12 That double-digit gain is going to be difficult, if not impossible, to replicate in the coming years based on current valuations, which have historically been reliable indicators of long-term returns. Nonetheless, we maintain an optimistic view on equities for 2021, based on our forecasts that company earnings growth will comfortably outpace total returns, enabling valuations to ease lower throughout the year. S&P 500 consensus earnings estimates have already risen from 20% to over 25% since January 1, in part thanks to a stronger fourth-quarter earnings season.13
Against that backdrop, we believe stocks remain a compelling investment choice for diversified portfolios over the balance of this decade. At the same time, it’s important for investors to choose their strategies wisely – focusing on their objectives, time frame, asset allocation and risk tolerance.