Strong jobs numbers,
but concerns remain

Despite strong expectations for continued job losses, the labor market surprised in May, generating 2.5 million net new jobs. The headline unemployment rate declined 140 basis points (bps) to 13.3% while the broader U6 unemployment rate declined by 160 bps to 21.2%. Although average hourly earnings declined during the month, that reflects the changing composition of jobs with lower-wage jobs coming back online. The opposite effect occurred in March and April when the loss of predominantly low-wage jobs artificially boosted hourly earnings. 

Despite the good news, caution abounds. A common refrain of ours: one month does not make a trend. Job growth could falter in the months ahead. Additionally, job gains came largely from the reversal of temporary layoffs, many in distressed firms that rehired because of support via government funding. The largest gains occurred in food services and drinking places, offices of dentists, specialty trade contractors (for buildings), and personal and laundry services. Yet permanent layoffs continued to increase during May, a troublesome sign. And because of an error by survey respondents, the true unemployment rates likely sit roughly 300 bps above the published rates. Nonetheless, the improvement supports our belief that the economy likely already passed its low point for the cycle. 

The ISM indexes for May also support our view that the economy passed the worst of the crisis. The ISM manufacturing index increased slightly from an 11-year low. Below 50 the index indicates contraction, but the increase hints that the decline is slowing. The ISM nonmanufacturing index performed similarly: the index increased in May, but with a reading below 50 it still signals contraction. Both indexes should further stabilize as the economy moves closer to growth once again, but they are not signaling recovery yet. 

The surprise employment gain potentially risks both additional rounds of fiscal stimulus (with some in Washington already declaring them unnecessary) and extensions of existing stimulus spending plans. That could prove ironic (and damaging) since many of the firms rehiring employees benefitted from government support. As government programs that support businesses and consumers expire, the economy could face an uncertain and challenging recovery path, especially without additional support. 

The stock market continued to rally following the surprise in the labor market. The S&P 500 now sits just below its year-end level. The market is responding to actual developments (such as the Federal Reserve effectively backstopping corporate America via the purchases of corporate bonds) and potential developments (such as the possibility of a quick resumption of economic growth). But the quick bounce back in the equity market reignited conversations about frothy valuations: the cyclically adjusted price-to-earnings ratio ended last week just below 30, not far from its year-end value of roughly 31. The only time the ratio reached higher levels occurred during the dot-com bubble.