News Channels Sell Suppositions about the Economy

stock market, U.S. Economy, Crystal Ball, uncertainty

The U.S. economy generated an impressive 266,000 jobs in November, in part reflecting the return to work of formerly striking GM employees. The Labor Department reported the unemployment rate ticked lower to 3.5%; revised upward jobs growth in September as well as October; and indicated that wage growth rose slightly to 3.1% year over year. Despite the robust jobs reading, the employment environment, which has been so strong for so long, has slowed a bit in 2019, with a year-to-date monthly average of 178,000 new jobs per month compared to the 2018 average of 213,000.

The jury is still out on the question of why we see this cooling effect.  However, suppositions abound and a few of the more plausible ones are increasing business uncertainty spawning from the trade wars and uncertainty out of Washington.  Though each has some merit, we are viewing it a bit differently; our economy, in terms of a business cycle, is at the stage where jobs growth tends to slow.  In other words, what we are experiencing is not atypical.  Of course, that doesn’t sell news so don’t expect your favorite news channel to provide this perspective.

We think the employment environment will continue to show modest growth, supporting overall economic growth. Many industries with good jobs growth in November included healthcare and professional and technical services.  Overall, the latest numbers should provide the Fed enough confidence to remain on the sidelines following (three) recent rate cuts.

We can point to many indicators that support a solid U.S. economy.  Still, the most common question we get from online readers, clients, and the general public is “what is the stock market going to do”?  Our answer usually includes a little humor – no one has a crystal ball.  But we do have some opinions about current stock prices and their eventual path.  Using the S&P 500 as our proxy, stocks are just above fair value, which we believe is around $3090.  This value takes into account factors such as stock prices, five-year normalized earnings (three historical years, two forward-looking), inflation, and T-bond and T-bill yields.

Since 1960, on average, the index has traded at 1.8% above fair value. By applying one standard deviation to fair value to determine a normal range, we find that the S&P 500 typically trades between 14% undervalued and 18% overvalued. We are now in that normal range. The steepest discount for stocks occurred in February 2009, when stocks were priced 48% below fair value during the depths of the Great Recession. The steepest premium occurred in August 2000, when stock prices topped 54% above fair value at the end of the “dot-com” boom. We think the valuation backdrop supports our constructive view of stocks. The upper bound of the current fair value range for the S&P 500 is above 3500, while the model targets fundamental support at 2500.

So, what does all this mean.  Well, let’s put it in simpler terms.  In general, stocks appear to be fairly to slightly over valued.  Upside potential is always a possibility and, barring any major headwinds, upward momentum has the advantage – in our opinion.  The downside is also a realistic concern but we don’t anticipate a seismic sell-off anytime soon.  We reckon that as long as the consumer spending is healthy, jobs growth sustains and payrolls increase, economic conditions will remain positive.  Moreover, trade wars with China are likely resolved by year-end or in the first quarter of 2020 – China is showing signs of their readiness to reach a solution with President Trump.  In our opinion, the market is priced at fair value with opportunity to above average performance.  Our strategies remain overweight in stocks given this backdrop.

If you have questions about the current U.S. economy, and how it pertains to your wealth management strategies, Talk to an OmniStar Advisor today.