On jobs, Friday’s employment report is shaping up to be a strong one with the potential for a 500,000+ gain in non-farm payrolls. The job gains are likely to be concentrated in the restaurant, entertainment, leisure and education areas that saw huge layoffs in the early days of the pandemic which are gradually being reversed as the economy slowly reopens. We also expect the unemployment rate to tick down from 6.2% to 6.0% even as more workers return to the job market. With very strong economic growth and limited legal immigration, we expect the unemployment rate to fall even faster than the Fed does, with the jobless rate averaging 4.2% in the fourth quarter of this year and 3.5% in the fourth quarter of 2022.
On profits, entering the first-quarter earnings season, a record number of S&P500 companies are issuing positive guidance, according to FactSet. This corporate optimism is also reflected in analyst expectations, which are looking for a 40% rise in S&P500 operating earnings in 2021 following a 22% decline last year. Strong economic growth should, of course, contribute to this. However, analysts are likely too optimistic in forecasting a further 16% gain in 2022, particularly given prospects for higher interest rates, higher wage costs and possibly higher corporate taxes, even as growth moderates throughout next year.
On inflation, last Friday’s consumption deflator readings were in line with expectations, with year-over-year inflation registering a moderate 1.6% overall and 1.4%, excluding food and energy. However, these readings will both likely vault well above 2% in April, due to easier comparisons with last year. Importantly, the pace of year-over-year inflation may stay above 2% throughout the rest of the year and into 2022, reflecting the impacts of supply bottlenecks and surging demand.
For the Federal Reserve, such an inflation outcome will likely lead to some discomfort as the year goes on. Broadly speaking, the Federal Reserve is utilizing three tools in trying to boost the economy: (1) near-zero short-term interest rates, (2) extensive bond purchases and (3) forward guidance that they don’t intend to ease off on these efforts anytime soon. However, if the economy continues to outperform their inflation and employment forecasts, their forward guidance may begin to lose credibility, as investors increasingly doubt both the wisdom of their policies and their resolve to stick with them.
This should mean further increases in long-term interest rates in the months ahead. This, of course, constitutes a threat to the bond market. However, it also suggests some risk to the overall equity market and, in particular, those parts that still trade at high multiples to earnings. For investors, in the calm before the surge, there is still time to check that portfolios are well diversified and have sufficient exposure to less expensive areas such as U.S. value stocks and both EM and DM stocks overseas.
David Kelly is chief global strategist at JPMorgan Funds.