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Productivity Booms As Labor Market Shows Signs Of Revival
When the labor market sneezes, ADP, Paychex, and ManpowerGroup catch colds. The stock prices of all three sold off sharply as hiring cooled starting early last year (chart). But on balance, the latest batch of labor market data suggests that employment conditions may be improving, and employment-related stocks may be bottoming (chart). We disagree with the widely-held notion that AI is a net job killer. In our opinion, AI will create jobs on balance. Humans will use AI to achieve greater output at lower cost, creating a wealthier society that needs more and newer types of human labor. We agree with Jevons' Paradox: Making a production input more efficient lowers the cost of the final product, stimulates demand for it, and ultimately results in greater demand for the input itself, despite the productivity gain. Let's review the latest productivity, labor costs, and employment data: (1) Productivity. Productivity is measured as nonfarm business output divided by labor hours worked. Output increased 3.3% y/y in Q1-2026, solidly above the comparable 2.7% rise in real GDP. Hours worked rose only 0.4% y/y. So productivity increased 2.9% y/y, exceeding its historical average of 2.1% (chart). In our Roaring 2020s scenario, productivity growth is likely to increase to 3.5%-4.0% over the remainder of this decade and continue at that pace through the Roaring 1930s. (2) Unit labor costs & inflation. Unit labor costs is measured as hourly compensation divided by productivity. It rose by 1.2% y/y in Q1-2026, the slowest pace of growth since Q3-2023 (chart). This confirms our view that the labor market isn't currently a source of inflation but rather disinflation. For now, the latter is being offset by other inflationary pressures, i.e., higher energy prices and tariff-related increases in durable goods prices. (3) Productivity & real hourly compensation. Inflation-adjusted hourly compensation is determined by productivity (chart). Businesses can only sustainably raise real pay when productivity gains provide the underlying economic value. We expect productivity growth to rise close to 4.0% by the end of the decade, supporting equivalent real hourly compensation growth (chart). (4) Corporate profitability. Strong productivity growth tends to widen profit margins. Profit margins are currently at record highs, and boosting corporate profits (chart). S&P 500 earnings growth has been surprisingly strong as a result. (5) Jobless claims. Initial unemployment claims ticked up modestly to 200,000, following the prior week's drop to 190,000, the lowest reading since 1969 (chart). The four-week moving average of initial jobless claims also fell to its lowest since January 2024. Continuing jobless claims dropped to 1,766,000 in the week ended May 2, their lowest level since January 2024. The four-week moving average of this series has now declined for nine consecutive weeks, the longest such streak since June 2022. Taken together, the consistent downward momentum in both series is a strong signal that hiring activity is improving, while layoffs remain very low low. (6) Layoff announcements. The May 7 Challenger, Gray & Christmas report showed that US employers announced 83,387 job cuts in April (chart). For the second consecutive month, AI was cited as the primary reason for layoffs, accounting for 26% of all cuts (roughly 21,490 jobs). Despite the monthly jump, year-to-date layoffs remain down 50% compared to the same period in 2025. This confirms that while specific sectors are being disrupted by AI, the overall labor market remains resilient. It is also entirely consistent with our belief that AI will create jobs on net. (7) Job growth. Yesterday, ADP reported that private-sector payrolls rose by 109,000 in April, the fastest pace of job creation since January 2025. The result is corroborated by Revelio Labs, which reported that total nonfarm payrolls rose by 66,400 in April, the most since March 2025, with gains led by health care and social services and the finance sector. We expect that tomorrow's April employment will show a big upside surprise.
The War’s Supply Shocks
Our friends at Capital Alpha released a great summary of the impact of the war in the Middle East on the availability of key commodities that are produced in the region and transported through the Strait of Hormuz. Even if the war ends soon, the ripple effects will continue to be felt around the world through the end of this year and perhaps next year too. … William focuses on the war’s impact on global food supplies.
Earnings-Led Meltup
We have nothing to fear but nothing to fear. Stock investors have been fearless since the S&P 500 fell to the year's low on March 30, when war-related fears peaked. The index has soared 16.1% since then to a new record high. Yesterday, we explained our Buzz Lightyear Theory (BLT) of the stock market. Investors have concluded that, thanks to AI, demand for "compute" will increase to infinity and beyond, and so will the earnings of the S&P 500, including the hyperscalers and the semiconductor companies, particularly those that manufacture memory chips. Even more fearless is the consensus of industry analysts. They didn't flinch during March when the war in the Middle East was raging. They raised their earnings growth expectations for 2026 that month and continued to do so, up to 21.4% currently (chart). They’ve also been raising their expectations for the level of 2027 earnings, but the growth rate for next year has declined in recent weeks to 16.9% simply because this year's upward estimate revisions have been so strong! That's mostly because companies have beat their estimates during Q4-2025 and now Q1-2026. The analysts may be starting to get “Buzzed,” as their expected long-term earnings growth (LTEG) for the S&P 500 rose to 20.2% during the week of May 5 (chart). It rose even higher during the pandemic, when fiscal and monetary policymakers both were slamming on the accelerator. But LTEG now exceeds the 18.6% peak of the 2000 tech bubble. So the recent melt-up in actual and expected S&P 500 earnings has weighed on the index's forward P/E. The PEG ratio, which is the forward P/E divided by LTEG, is down to 1.03 (charts). The market looks cheap unless earnings growth expectations for the rest of the Roaring 2020s and the early Roaring 2030s get bashed, as they did after the Tech Wreck of 2000. What could possibly go wrong? Yesterday, we observed that if China invades Taiwan, stock markets around the world would plummet. For the here and now, it's not clear that the war in the Middle East is over. Supply-chain pressure caused by the war rose sharply in April (chart). The price of oil remained around $100 a barrel today despite reports that the US and Iran might soon sign a one-page letter of understanding. It would include reopening the Strait of Hormuz and a 30-day framework to resolve major disputes, including the most divisive nuclear issue. The resilience of the US economy continues to be confirmed by economic data and earnings reports. Consider the following: (1) Jobs. Private-sector payrolls rose by 109,000 in April, the fastest pace of jobs creation since January 2025 (chart). That's according to ADP. Gains were led by services, with education, healthcare, trade, transportation, and utilities all adding jobs. Construction employment increased at a solid pace, which we think reflects the ongoing AI data center build-out. ADP also reported that wages for job-changers rose at a healthy pace of 6.6% y/y. The April ADP jobs report confirms our call that the labor market is improving. (2) Consumers. The latest earnings results and CEO commentary leave no doubt that American consumers continue to spend. Uber reported that its delivery business achieved a 34% revenue increase and its ride-hailing business a 5% increase. CEO Dara Khosrowshahi told CNBC that "the consumers are spending, they're spending locally, and we don't see any signs of that weakening at this point." Disney reported a 7% increase in revenue at its experiences division, which includes cruises and theme parks, and a 2% rise in theme park attendance. Management reiterated that "current demand at our domestic parks and resorts is healthy" and that the company is "encouraged by current demand and expects year-over-year attendance at our domestic parks in Q3 to show improvement compared to Q2 results." (3) Bonds. In its Quarterly Refunding Announcement, the US Treasury confirmed that nominal note and bond auction sizes will be kept unchanged for "at least the next several quarters." Treasury Secretary Scott Bessent is maintaining issuance tilted toward the shorter end of the yield curve. T-bills currently make up roughly 22%-23% of total outstanding marketable US debt, above the 15%-20% range historically recommended by the Treasury Borrowing Advisory Committee (chart). Bessent previously criticized former Treasury Secretary Yellen for relying heavily on short-term issuance, arguing that it amounted to market manipulation for political gain. Now, Bessent, like Yellen, is hoping to keep bond yields from rising. He has nothing to fear but the Bond Vigilantes.
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