Over the long Easter weekend, the one big piece of news was the very strong March employment report. Our economy added over 900,000 jobs as it recovers from the pandemic. The unemployment rate fell to 5.9%. There were some concerning numbers in the data. There are still over 8 million fewer Americans employed than were working pre-pandemic. The labor force participation rate has stalled at around 61.5%; it had been closer to 63% earlier. Finally, over 43% of unemployed workers have been out of work at least six months. Average hourly wages actually fell slightly in March. This was almost certainly due to a shift in the mix of newly employed workers, not any cut in rates paid. But the big numbers were the number of jobs created and the drop in the unemployment rate. Markets were closed Friday as noted. Futures point higher this morning.
The labor numbers put an exclamation point on the state of our economy and the pace of recovery. The data was collected in mid-March. The next two months will show similar growth. Several states are now opening up vaccination opportunities to all adults as the most vulnerable have been vaccinated or at least had the opportunity to get shots. While there is the possibility of a fourth wave of Covid-19, the number of occupied ICU beds is down, as are the number of deaths. The disease isn’t going away, but the fear of dying or severe cases is fading. That will push life back in the direction of normal as spring rolls into summer. You see the behavior changes. Those unwilling to eat away from home are starting to eat outdoors. Those who have eaten outdoors and are vaccinated are now willing to eat inside. Plane traffic just a couple of months ago was down two-thirds from 2019 peaks. That gap is now cut in half. The changes in our daily behavior are palpable.
Along with the recovery, however, has come some shortages and spikes in commodity prices. Suppliers during the height of the pandemic, starving for cash without revenue, cut inventories to the bone. When demand returned, what inventory remained got depleted. Soon buyers were scrambling to fill needs. Demand surges further aggravated shortages. In some cases, the shortages will dissipate rather quickly. OPEC, for instance, is increasing production in response to stronger demand and higher prices. But some shortages, such as semiconductors, may take a year or more to be fully resolved. In some cases, that will stifle economic activity. Auto makers are cutting production for lack of electronic components.
Beginning in a little over a week, companies will start reporting first quarter earnings. They should be excellent, with the obvious exception of the travel and leisure industries and other slivers of the economy still impacted by Covid-19 shutdowns. But virtually every sector is moving in the right direction.
As we often point out, the absolute level of earnings is less important than how they compare to expectations. Stocks price in both past data as well as current expectations for future growth. One would hope that as the economy moves forward at an accelerated pace, expectations can rise. They undoubtedly will. But there will come a time when expectations get too optimistic. That is why sometimes you see a stock decline on great earnings. Conversely, some stocks go up on bad earnings if the numbers still exceed forecasts. Because the U.S. economy is gathering steam even faster than optimists expected, I don’t think we will see a lot of disappointments this quarter. There will be a few exceptions in industries impacted by supply chain disruptions and component shortages.
Clearly, the pandemic changed how we live and how we work. Life will change again as the pandemic fades, but it won’t return to exactly where it was in early 2020. There will be less demand for office space. Many large retailers and local restaurants closed their doors, never to reopen. Housing demand surged as people chose to move away from urban centers. Demand for takeout and delivery increased, probably permanently. Retailers now fully realize the importance of an omnichannel presence.
All of this creates a new list of winners and losers. Most have been identified by investors, but the winners will face more competition. Some of the losers will adapt and remake themselves. Malls tomorrow are likely to look quite a bit different than today. Conventional retailers will be replaced by services. Old dated conventional retail stores will be replaced by hot Internet brands. You can buy a Tesla in a mall, even test drive one while you are there. The metamorphosis isn’t complete.
Maybe the biggest surprise last week was that bond yields didn’t jump along with the good economic reports. Wages, as noted, show little sign of taking off. The spike in many commodity prices will start to level off as production rises to meet demand. Nothing generates more supply than higher prices. The assumption that escalating demand will be accompanied by a surge in inflation may be an overstatement. Obviously, if demand rises faster than supply, higher prices are ultimately inevitable. But technology and the price discovery attributes of the Internet remain powerful deflationary forces. If productivity can increase greater than its long-term average, the rate of inflation can be held in check, meaning within boundaries set by the Fed of 2-3%.
Normally, inflation dictates long-term rates. But life in the bond market isn’t normal if the Fed is buying $120 billion of bonds per month. Those purchases are an obvious depressant to rates. The Fed says these purchases are needed to sustain a fragile economic recovery. Am I to buy that 8%+ growth expected in Q1 is “fragile”? Washington puts labels on actions and legislation to rationalize what is being done. The Affordable Care Act was never about controlling the cost of medical care, it was about access to care. The recent Covid-19 recovery bill had little to do with treating the disease or preventing the spread. It was a lower and middle class economic relief package. The so-called infrastructure bill announced last week has more money allocated to seniors than it does to infrastructure. In a similar vein, the Fed’s actions are tied to the need to keep rates as low as possible, to allow the government to fund its activities with the massive use of debt. The only way rates can be kept low as inflation rises is for the Fed and other central governments to buy bonds. Will this tactic work? This is all a grand new experiment. It will take us months or even years before we know if the explosion in debt has unintended consequences. If it does work, we face years of growth and prosperity ahead. If it doesn’t work, both government and markets will have to adjust. It’s simply too early to guess the ultimate outcome.
For now, however, surging earnings and a slow pace of interest rate increases should continue to move stock prices higher.
Today, Pharrell Williams is 48.
James M. Meyer, CFA 610-260-2220