After the best start to a year since 1997 for the S&P 500, stocks finally fell in August, ending a five-month win streak. The S&P 500 closed the month down 1.8%, but that was after a late-month rally brought it back from a loss of 5%.
- Stocks fell in August, as expected after a big start to the year.
- September is typically the worst-performing month, but there are some indications this year will buck that trend.
- The bull market is alive and well, and we continue to expect new highs before year-end.
- Job growth has slowed from a torrid pace to an average gain of 150,000 over the last three months. That is more than the economy needs to keep up with population growth.
- The unemployment rate ticked up to 3.8%. However, more people stayed in the labor force to look for work, which is a sign of confidence in the labor market.
- Overall income growth remains strong, even after adjusting for inflation. That’s encouraging for consumption and the economy.
This seasonal weakness is not surprising, as we expected stocks to take a break after a huge rally. The good news is this is normal market behavior. The bad news is the worst month of the year is now upon us.
By historical measures, September is the weakest month. In fact, it has had the worst performance average since 1950, down 0.66%. During pre-election years, it has also been the worst-performing month over the past 20-year and 10-year time frames. So, we might not be out of the woods just yet, but there are signs the year may improve.
Market history shows that down years heading into September tend to see poor returns. For example, last year stocks dropped 9.3% in September after having fallen 17% on the year. This year, however, stocks are on firm footing, likely mitigating the risk of a continued slide.
Our research shows that when stocks gain more than 15% after the first seven months of the year and then fall in August, the chances of a strong September are quite high. Under this scenario, stocks have been higher eight out of nine times with very solid returns. Even more encouraging, stocks have never closed lower for the remaining months of the year, averaging a gain of more than 11%. If that trend continues this year, stocks will close at new all-time highs, which we think is quite possible.
The Labor Market Is Also Normalizing
At the beginning of the year, we labeled our 2023 outlook “The Edge of Normal” as we expected markets and the economy to normalize in 2023. So far this year, our view has been confirmed, so much so that our mid-year outlook was titled “Edging Closer to Normal.” Normalization has now continued into August. Of course, normalization also means that employment is easing from red-hot levels, and that’s easy to confuse with a slowdown that foreshadows a recession.
The economy created 187,000 jobs in August, which was above expectations for 170,000. These numbers can be volatile, as we were reminded by the downward revisions to prior data. This is why it helps to look at the three-month average, which is running at 150,000. That is more than enough to keep up with population growth, and it also indicates the labor market is normalizing.
Within the payroll data were encouraging signs, including the fact that cyclical sectors such as construction and manufacturing added 38,000 jobs in August. There were also one-off factors that impacted the report, including the Hollywood writers’ strike, which pulled employment in the motion picture industry down by 17,000.
The unemployment rate did jump from 3.5% to 3.8%. But this was for positive reasons. The Bureau of Labor Statistics (BLS) counts a worker as unemployed only if they are “actively looking for work.” In August, 736,000 more potential workers came into the labor force (as defined by BLS) to look for work. That’s the largest monthly increase since January, and that would only happen if workers were confident that the labor market was strong. Usually, during weak labor markets, workers get discouraged and stop looking for work and they’re assumed to have left the labor force.
This issue with the unemployment rate is why we prefer the employment-population ratio, which is sort of the opposite of the unemployment rate. It measures the number of employed workers as a percentage of the civilian population. We also review that metric for “prime-age” workers, i.e., those between the ages of 25 and 54, since that removes the impact of an aging population. (As baby boomers retire, they leave the labor force.)
Encouragingly, the prime-age employment-population ratio was unchanged at 80.9%, which is the highest level it has been since 2001. In fact, the prime-age employment-population ratio for women is at 75.3%, which is a record high. It’s interesting that this statistic does not make more headlines. These metrics indicate the labor market is the healthiest it has been since the late 1990s.
Ultimately, what matters for the U.S. economy is consumption, and for that it needs income. Overall weekly payroll growth across the economy rose at a whopping 7.2% annual pace over the last three months. That’s because:
- Employment growth has been steady.
- Workers are working more hours.
- Wage growth remains strong.
Overall inflation has been running close to 2% over the last three months, thanks to lower energy prices, as well as disinflation in food, vehicles, and other goods impacted by pandemic-related supply chain issues. As a result, real incomes, i.e., incomes adjusted for inflation, have grown at close to a 5% annual pace. This does not signal an economy close to recession.
Barring unforeseen shocks, no recession is in sight. The economy is normalizing, but that should not be confused with a slowdown. The labor market remains healthy, and incomes are growing above the pace of inflation, which is good news for consumption and, hence, the economy.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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