Based on the broader market rotation we saw in Q2 and into Q3, it appeared investors were worried that cyclical economic growth was already slowing. But a raft of data over the past week threw a bucket of cold water on this theory.

Right now, there are generally three camps of “worriers” in markets: those worried about inflation, those worried about growth peaking (especially given emergence of the delta variant) and those worried that stocks are just too expensive. Amid this cocktail of uncertainty, investors broadly rotated into sectors of the market that tend to do well later in the business cycle. For weeks now, we’ve said this is premature, and the numbers are proving out our thesis as time goes on. Cyclical growth is still strong, and there was something in the data to calm all three camps of “worriers” last week. So, with that, let’s take a deeper look.


Manufacturing Expands Despite Headwinds: July’s ISM Manufacturing PMI pulled back to 59.5 percent, a decrease of 1.1 percent from June’s 60.6 percent. The index has been moderating for the past two months after setting a 47-year record back in May, but July still marked the 14th straight month of expansion in the sector (a read above 50 indicates growth). The storyline remains much as it has throughout summer: Suppliers are having difficulties meeting a wave of demand unleashed as the economy reopened. Scarce labor, material shortages and high commodity prices remain driving factors here, but some of those pressures may be abating.

On prices, for example, ISM Chairman Timothy R. Fiore said, “Supply and demand dynamics appear to be moving closer to equilibrium for the first time in many months.” While commodities costs broadly rose in July, they rose at a slower pace. Lack of labor and material shortages also improved in July, and that should continue improving in fall as enhanced unemployment benefits expire and kids return to school, allowing more parents to work.

Similar Strengths, Challenges on the Services Side: The ISM Services PMI, representing the larger share of the economy, remained in expansionary territory for the 14th straight month in July (it’s been expanding 136 out of the past 138 months), and the month’s reading of 64.1 represents an all-time high for the index. It’s a strong bounce from June’s reading of 60.1. Rising costs, competitive labor markets and slower supplier deliveries remain headwinds, but pent-up demand is still driving historically high levels of business activity. Inventories remain lean, which, again, serves as a solid indicator of productivity growth.

Another interesting observation: Export orders spiked, likely driven by economies reopening abroad. This could further bolster the global growth story over the nearer term.

Growth Trend Remains Strong: Taken all together, services and manufacturing in the U.S. are charging ahead despite some tangible headwinds. Not only is there strong new order growth in services and manufacturing (above in 60 both surveys), backlogs are also near records — all against historically low levels of inventory. Pair that with roughly $1.6 trillion in consumer savings waiting on the sidelines, and that’s a potent catalyst for the economy. That’s why we believe there are plenty of reasons to expect elevated growth trends through the year.

Unemployment Report: The U.S. added 943,000 jobs in July, the fastest pace of job growth in nearly a year, and overall unemployment fell to 5.4 percent from 5.9 percent in June. Notable job gains were clustered in the leisure and hospitality sector, which is closely linked with the trajectory of COVID-19. Overall, it was an incredibly strong jobs report.

Jobs data also indicate there’s plenty of labor slack in the economy, which can help keep inflation at bay as the economy grows. Based on our calculations, we need roughly 6.1 million people to get hired to recoup job losses from the pandemic. We also remind that 3.2 million people have stopped looking for jobs, and another 2 million workers have entered the workforce. That headline 5.4 percent unemployment rate likely undershoots the total number of workers on the sidelines (to be counted as “unemployed,” you have to be looking for a job). Put it all together, and you’ve got anywhere from a 9- to 11-million employee labor force gap that needs to close.

Big picture, a healing labor market translates to higher aggregate income, which ultimately allows policymakers to pare fiscal support and let the private sector drive the economy. All the while, there’s enough available labor to keep inflation moderated.

For Those Concerned About Valuations: For those worried about expensive markets: Earnings continue to beat, and companies continue to justify stock valuations. Remember, stock valuations are relative, not absolute. So stocks are only expensive (or cheap) by comparison to other asset classes. Currently, the 10-year Treasury yields 1.29 percent. Depending on your current view of inflation, that’s a negative yield return right now. If the Fed is aiming to keep inflation around 2 percent over the next 10 years, in that environment equities continue to look attractive relative to other assets. When someone says, “Stocks are too expensive,” be sure to ask them, “Compared to what?”

This isn’t to say investors should sell their bonds given the current yield environment. Bonds play an important role in long-term portfolio construction. The point is simply that stock and bond valuations should always be placed in context.


Consumer Price Index: Markets will be awaiting another inflation checkup this week. Inflation has been the focus for some time in markets, so there’s not much preamble required here. Markets will be looking to see if inflation trends are showing any signs of abating or if there are indications that it’s stickier than expected. Given feedback from ISM surveys, wholesale car prices and auto sales, there’s reason to expect evidence that the pace of recent price increases is likely to begin moderating.

NFIB Small Business: This week we’ll get another check from small business owners in July’s NFIB report Tuesday. Apart from the typical reads on sentiment, we’ll be particularly interested in survey respondents’ views on the employment situation. Is it still challenging to find workers amid soaring demand, or are some of those labor pressures beginning to ease (or do business owners at least foresee them improving)? Of course, the impact of prices and supply chains will also be worth noting, given the broader macroeconomic environment.

Consumer Sentiment: We’re hoping to get insights into several key themes that are driving markets when the University of Michigan releases its consumer sentiment survey on Friday. We’ll want to see how — or if — consumers are changing their purchasing behavior in response to rising prices. The survey should also capture any headwinds stemming from the emergence of the delta variant around the country. Are consumers growing more cautious or still feeling pretty good about their balance sheets?

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