Digging Beneath the Surface

Digging Beneath the Surface

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The July Jobs Report Tells a More Complicated Story

The Bureau of Labor Statistics reported a job loss of 23,000 for July, but the underlying data is vastly more revealing. A large decline in government employment more than fully accounted for the decline. The unemployment rate also fell, but mostly due to yet another decrease in the workforce. More people left the workforce than lost their jobs. And that workforce decrease reflects the ongoing change in U.S. immigration policy.

A Shrinking U.S. Workforce Is Reshaping the Labor Market

The private sector continues to add workers to payrolls, while the labor market keeps getting tighter, as immigrants return home. Wage inflation was quite moderate at +0.1% for the month, but this may not be sustainable. Still, the Fed can maintain its current policy stance and wait for progress on reducing inflation to see if it moderates, as they hope.

As we have warned multiple times over more than a year, the U.S. workforce is declining, because the border is closed and the government works to repatriate immigrants to their home countries. Young people are entering the workforce, but they are nearly offset by retiring baby boomers. There are simply fewer people available to be hired.

So, hiring falls along with the unemployment rate. That scarcity in the labor market is also reflected in an exceptionally low level of initial unemployment insurance claims. Firms are holding onto labor. With labor scarcer, it wouldn’t take much hiring to push wage inflation higher, although we haven’t seen that in the data, as yet.

With wage inflation fairly stable, the ongoing large gains in productivity offset much of the rise in labor costs, so there is some basis for hoping that inflation recedes, a thesis pushed by some Federal Reserve officials. Time will tell if this view will prove to be correct. In the meantime, there is no urgency to hike rates to rein in inflation if it may come down on its own.

Economic Growth Remains Resilient

Economic growth remains quite solid. Reshoring, massive investment in AI and all of its supporting industries, favorable investment policies and some urgency to replenish military supplies continue to stoke the U.S. economic engine. Large gains just above 2% at an annual rate in productivity improves living standards, which accounts for the resiliency in household spending.

In contrast, in our analysis, there are simply no significant weaknesses or excesses that might trigger a recession in the visible future. What issues exist, such as an overbuilt office space or credit quality concerns, result in weaknesses in those narrow areas without undermining the overall economy.

Corporate profits are rising very strongly, enabling most firms to improve their balance sheets or to increase capital investments, which reinforces growth in the economy. We believe a solid expansion is locked into place for the balance of 2026, likely into the first half of 2027 and perhaps beyond.

Corporate Earnings Continue to Support the Stock Market

Stock prices have enjoyed quite a rally over the past 12 months (or more). There is some tendency to focus on the rise in stock prices without looking beneath the hood to judge if the rally is justified by a commensurate rise in profits.

Indeed, it has been and projections of profits for the next 6 and 12 months suggest the rally can continue. Solid economic growth results in solid profit gains. As noted by Goldman Sachs, 65% of S&P companies have reported earnings at least one full standard deviation above expectations, which is one of the highest such rates ever. And these gains in profits have broadened to include sectors besides tech.

Moreover, profits have increased even more than share prices over the past year, so the market has actually gotten cheaper, despite the rise in share prices. And profit margins are at record highs. The S&P now trades at 20.7 times forward earnings estimates, hardly an inflated level.

What Could Challenge the Economic and Market Outlook?

What could derail the current positive outlook? Wars always introduce a major element of uncertainty, but that is more of a political issue. Wars also increase government spending, which reinforces growth. Wars also increase innovation.

The entire defense budget must adapt to the new found glaring need for drones, missiles, anti-missile missiles, autonomous military equipment and the information systems to run them. Existing military doctrine and equipment have become obsolete almost overnight, which is stoking increased spending on defense. In time, these innovations will also improve living standards as they are adapted for peaceful uses.

So, we remain very positive about the prospects for the domestic economy, as well as for the equity market, which we believe will reflect those gains. The latest jobs report was very much consistent with our expectations.