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Good May Job Gains, But a Long Road to Recovery

Wells Fargo Investment Institute - June 8, 2020

by Gary Schlossberg, Global Strategist and Paul Christopher, CFA, Head of Global Market Strategy

Key takeaways 

  • The June 5 employment report was unexpectedly strong in jobs created and an unemployment rate that saw a decline (instead of a rise).
  • Some caution is in order, however, as many features of the report suggest that the road to recovery is likely to have many twists and turns along the way.

What it may mean for investors 

  • We continue to expect equity market volatility and recommend that investors use the recent rally to reallocate towards quality asset classes and sectors. 

Surprisingly strong employment report for May has implications for the second half of 2020 

Last Friday’s employment report was unexpectedly strong in jobs created and an unemployment rate that saw a decline (instead of a rise). The trend in continuing unemployment claims has improved somewhat recently, and it is in line with the May employment report showing that some workers have been called back. However, the decline was more than we expected to see this soon as businesses start to re-open. 

Most encouraging, hiring strength was most notable in many of the industries that suffered the most during the nationwide lockdown. The Leisure and Hospitality sector has been a focus of the lockdown. Restaurants and bars shed 5.4 million jobs in April but added 1.37 million jobs in May. Meanwhile, construction payrolls rose by 464,000 in May, erasing nearly half of the 995,000 jobs that April took away. Construction jobs returned in both homebuilding and nonresidential construction. 

Other measures, particularly the increase in the average workweek, imply that the economic recovery probably began in May—at least a month earlier and likely stronger than we had been expecting. The economy may well have a stronger second half in 2020 than we had anticipated, even if fourth-quarter growth moderates from a powerful third-quarter pace. 

Fallout from May’s blockbuster employment report extends beyond the timing and strength of the economy’s recovery to the monetary and fiscal policy debate and, arguably, the stock market’s rally and the November elections. Encouraging economic data likely will add to investor interest in the June 10 FOMC (Federal Open Market Committee) policy announcement—specifically the Federal Reserve’s plans for added monetary stimulus. The economy’s more upbeat tone also could influence the debate in Congress and with the White House over another fiscal-support package expected later this month. Economic optimism also could provide a shot in the arm to the president’s poll numbers. Lastly, signs of strength help validate the stock market’s latest rally and, perhaps, provide a base for further gains despite rich market valuations. 

The long and winding road to recovery is just beginning 

We expected employment to rise as businesses reopened in the spring. In fact, nearly 75% of last month’s employment gain came from a 2.7 million decline in furloughed workers. That contributed to a decline in the unemployment rate to 13.3% from 14.7% in April (or to 16.3% from 19.7% the previous month if millions of temporarily laid off workers had not been classified as employed). By contrast, an increase in permanent layoffs actually added to the jobless rolls. That increase may reverse if, as expected, growth from the reopening ripples across the economy. 

Nevertheless, several points argue for continued patience with the economic recovery: 

  1. At least some of the furloughed workers and recent increases in what the Labor Department describes as “permanently” unemployed may not be called back as quickly—or maybe not even at all—if the recovery is disrupted or growth remains too weak to rehire them.
  2. Unemployment, at 21 million, remains far above anything experienced in the past 70 years, pointing to a long road ahead for a full labor-market recovery in the absence of an unlikely economic boom.
  3. Also, consider that other parts of the Leisure and Hospitality industry were not as fortunate as restaurants and bars. Jobs at hotels declined by a further 148,200 jobs in May, leaving employment in this sector a little less than half of what it was one year ago.
  4. In total, restaurants have hired back roughly 23% of the workers they let go in March and April. While we expect some follow through in June, some large chains have already warned that business has not come back as quickly as they brought back workers, and they are now reducing hours and asking workers to take unpaid leave.
  5. Future job growth could face headwinds from further cuts by businesses unable to hang on until a recovery is fully on track, along with local and, particularly, state layoffs responding to cuts to balance budgets. Most of May’s decline in public-sector employment was in education and other local-government jobs, leaving jobs at the state level particularly vulnerable. In the corporate sector, May’s announced layoffs of 400,000 workers, though down from April, still were more than five times higher than the long-term average. 

We conclude that the economic recovery may begin sooner than we had thought, but the road to recovery is likely to have many twists and turns along the way. We expect the economy to be tested by a staggered reopening and a potentially cautious response by consumers to the reopening in the absence of a vaccine, immunotherapy, or adequate testing safety net. Moreover, there’s the risk of renewed increases in the COVID-19 infection rate, plus increased bankruptcies and fresh layoffs in some sectors of the economy even as others are slowly improving. 

Investment implications 

We continue to expect some range trading in the S&P 500 Index in the coming weeks and months. It’s good to see the economy starting to rebound now, and that does suggest a stronger third-quarter rebound than we had expected. But that and a lot of positive expectations (for example, COVID-19 infection rates in the months ahead) have been priced in. It’s still early to confirm these positive trends in the economy, and we still foresee volatility without support from improving earnings. 

Our guidance to investors since early March has been to be overweight U.S. Large Cap and U.S. Mid Cap equities, but to stick with quality sectors—those where firms have good cash flow, good cash/debt ratios, and good earnings prospects. Those sectors are Information Technology, Communication Services, Consumer Discretionary, and Health Care. We also favor Financials, but more from a valuation perspective. We favor rotating funds out of Industrials, Energy, Materials, U.S. Small Caps, and international markets.

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