• Harsh Patel, CFA

Back to Work? 🇺🇸 🤷‍♂️


In case you missed it, financial markets - especially those in the US - rallied hard yesterday on the back of the latest US jobs report.


The jobs report for May which was based on a survey conducted between 10-16 May showed US unemployment falling to 13.3% after climbing to 14.7% in April. According to the report, the US economy added a net 2.5m jobs for May. 


This came as a shock for most people who follow these things - including yours truly - as consensus expectations for May were for the unemployment rate to rise further with a net 9m people becoming unemployed. In other words, economists and market watchers missed the mark by a massive 11.5m people. 


The resulting market optimism on the back of such an unexpectedly positive piece of economic data was strong - taking us to a point where the S&P500 stock index has recovered to being basically unchanged in 2020 while the tech dominated NASDAQ 100 now sits almost 10% higher in 2020 at an all-time record high.


If you thought all of the above doesn't really add up, or at least doesn't really reflect the current reality in the US, you're not alone. Many people across the spectrum - investors, traders, commentators - have struggled to reconcile the fact that financial markets have been so robust while the economic reality has felt so far from being robust in recent weeks. Perhaps this jobs report helps address some of that disparity, with the economy seemingly beginning to catch up with the recent stock market rally.


And so, it looks like Americans are headed back to work in seemingly large numbers with the reopening of the US economy under way. 


Obviously President Trump didn't miss a beat, organising a press conference following the release of the jobs report to go on a mostly incoherent, factually incorrect and at times downright offensive 45 minute long rant which re-iterated his tweet claiming it was all basically thanks to him(!) 


But let's not get distracted from the economic data at hand here. 


What drove US unemployment lower?


The truth is, we don't yet know for sure. 


But we can point to a few underlying drivers which could have caused this unexpected strengthening in the US labour market:

  • The Payroll Protection Plan

  • It's possible that the payroll protection plan which was part of that huge $2.2 trillion of fiscal stimulus agreed upon back in April started kicking into gear last month, helping companies re-hire employees they had initially laid off in April. This seems like the most likely reason for the unexpected unemployment surprise. 

  • Classification errors

  • The US labor department which compiles the jobs report noted there had been a classification error in which some people had been incorrectly classed as "employed but absent from work" instead of "temporarily laid off". Without this classification error, the unemployment rate would have been around 16% - higher than the 14.7% recorded in April. Classification and other statistical inconsistencies can and do crop up when you're in the middle of a crisis and trying to take stock of a rapidly evolving situation, so this could be part of the reason but still doesn't fully account for the surprise data we received yesterday. 

  • Food & drink

  • We saw an increase of 1.4m people employed in "Food services and drinking places", which seems odd given most of these establishments were closed during the survey period, and those which remained open probably didn't see enough demand to warrant being fully staffed. While this accounts for a large chunk of the 2.5m jobs added in May, it isn't enough on its own to drive such a large surprise in the data. 

  • Robust growth and employment

  • It could be that the US economy is just a lot more resilient than everyone thought it ever could be, with economic growth and employment picking up in May. This seems like the least likely situation however as large swathes of the US economy was still shut in May with people still mostly locked down at home. This would also be inconsistent with most other pieces of economic data we have seen coming out of the US, including weekly jobless claims. 

We think at this stage it's a bit too early to extrapolate or reach a definitive conclusion on whether the US economy is really bouncing back strong or whether the US jobs report was more of an anomaly. 


That why we'll be keeping our eyes glued to more economic data coming out of the US over the next few weeks in order to see whether it reinforces or disputes what this jobs report seems to be telling us.


How should I think about this?


Well, it's worth putting things into perspective.


Even if the unemployment rate declined - definitely positive news - it's still pretty elevated at 13.3%. That means there are over 20 million people still out of work. For perspective - this is still a historic high and well above the c. 10% unemployment rate we saw in the depths of the global financial crisis.


Translating this into a more relatable healthcare metaphor - the "economic" patient has come off life support but is still in the intensive care unit. And there's still a fairly meaningful risk that this patient goes back on life support if we have a second wave of infections across the US. 


In terms of where we are now, it feels as though the upside in US equities could be limited from here. Although it would take a brave investor to bet against the US stock market at given it's recent performance. At the same time, It's worth noting that downside risks still remain in the form of a second wave of infections and/or additional layoffs once the Payroll Protection Plan and other fiscal stimulus has been largely spent and/or a slower-than-expected return of consumer demand in the economy. 


So is the US stock market rally sustainable? 


Maybe, but we're starting to question this. 


The rally in recent days has been led by stocks which had previously been beaten up - the real economy names which looked in real danger just two weeks ago seem a lot stronger already if you were judging by their share prices alone. This includes US airline companies, cruise operators, oil & gas companies and leisure & hospitality stocks.


Until we actually see more economic activity on a sustained basis, we're not convinced that the above stocks should be rallying so much just based on "optimism about the future" alone. 


To us, it's increasingly looking like investors are starting to chase after the rally, driven by FOMO. Perhaps a classic sign that we may have gone "too far, too fast". 


Other options


Given the fact that it's rarely a good idea to actively bet against US stock markets, we would instead argue that there are better risk/reward investment opportunities out there right now anyway.


For example, following our last newsletter covering why Europe may finally be on a strong road to recovery, we've seen a pretty spectacular rally in European stocks with the German, French, Spanish and Italian stock markets all up c. 10% this past week alone. 


It's now slightly trickier to establish how much further they'll climb in the short run, but we still believe the European economy as a whole is well positioned to win in the long run if they can nail down and execute on their fiscal spending plans. 


This is because, for what is probably the first time in the history of the EU, these fiscal plans are well aligned with the monetary policy coming out of the ECB, which announced an additional €600bn in bond purchases this week - more than the €500bn expected by the market. With the EU's fiscal and monetary policy finally pulling in the same direction, we'd be inclined to watch this space. 


And watch this space, we shall 🍿🥤


Until next time!


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Evarvest Limited refers to the Evarvest network and / or one or more of its subsidiaries, each of which is a separate legal entity.