Uncategorized, Weekly Update

A Mixed Bag Economy

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Published August 30, 2019


Liz Ann Sonders at Charles Schwab recently wrote a thorough overview of the current economic state. Given the latest increase in economic uncertainty courtesy of the ramping of the trade war—but also last week’s release of the Leading Economic Index (LEI), her report is worth posting here for our subscribers who are interested in tracking the economy and musing about where that might be headed. We frequently post analysis and commentary from Charles Schwab as they take a different approach to investing than we do. They, like most all brokers and advice peddlers, are almost entirely buy-and-hold, asset allocation investors. One benefit of tracking their work is that when they become cautious, it typically is worth paying attention to – e.g. they don’t sound warnings very often. With that context, we hope you will find the economic overview below of interest:

Herewith is her article entitled “Leading indicators flashing limited recession warning.”

“Let’s start with a quick look at economic uncertainty, as quantified in Bloomberg’s U.S. Economic Policy Uncertainty Index. It is a highly volatile index, but should elicit no surprise that it recently spiked again.

Spike in Economic Policy Uncertainty

Spike in Economic Policy Uncertainty

As mentioned, the Index of Leading Economic Indicators (LEI) was released last week by The Conference Board. It surprised on the upside for a change. The index rose 0.5% month/month after two prior months of declines; with weakness in the manufacturing components as well as the yield curve offset by strength in unemployment claims and building permits. It was in keeping with what we’ve been discussing, which is the still-firm dividing line between the weak (albeit smaller) manufacturing portion of the U.S. economy and the stronger (and larger) consumer portion.

CEOs’ outlook = weak

Of growing concern though is the potential blurring of this dividing line if business malaise morphs into consumer malaise. There are signs this could be in the early stages. Prior to the market chaos of August 23rd, Chief Executive magazine released their “CEO Confidence Level in Business Conditions One Year From Now.” The Confidence Level fell 6% in August and is now considered a “weak” outlook. In addition, the University of Michigan measure of Consumer Sentiment—which post-dated The Conference Board’s release of Consumer Confidence—dropped to the lowest level of this year; with losses spanning all components.
For now, even though consumer sentiment has been dented, consumer spending has held up. That said, there is a reason why manufacturing indicators dominate the LEI relative to services or consumer indicators: they tend to lead overall shifts in the economy. The chart below shows the year/year change in the LEI; and what is currently the third major shift down in growth. Thanks to last month’s strength, it is not yet approaching the average reading heading into recessions historically; but it bears watching.

LEI in 3rd Slowdown This Cycle

LEI in 3rd Slowdown This Cycle

Better or worse…

I’m a bit of a broken record when it comes to analyzing economic data and connecting those dots to the stock market and/or economic inflection points: “Better or worse tends to matter more than good or bad.” In that vein, take a look at the table below showing a relative scorecard of major economic indicators. Although the levels of the leading and coincident indicators remain mostly green (strong) and yellow (fair), there has been a pickup in the number of red (worsening) trend readings.

Major economic indicators

In addition, there are now two out of four components of the Coincident Economic Index (CEI) that are worsening. As a reminder, those four components are (not coincidentally) the key metrics analyzed by the National Bureau of Economic Research (NBER)—the official arbiters of recessions—to declare and date recessions.

History of CEIs around recessions

My research colleague, Kevin Gordon, recently did a deep dive look at the history of NBER declarations and the trajectory of the CEI’s components heading into recessions historically. Using NBER’s own indexing methodology, the series of charts below show several important historic trends. First, when the NBER concludes a recession is underway they then go about the task of dating its start month—which is generally around the peak in economic activity.

The date noted for each cycle is the date that the NBER made the announcement of the start date of each recession (noted by the gray bars). The fact that the NBER looks back to near the peak of activity to date recessions’ starts is why you’ve been hearing (including from us) that if we are heading into a recession from today’s level of economic growth, it’s possible the NBER could ultimately date it as having already begun. That is not my base case (nor the LEI’s message); but worth pondering nonetheless.

2007-2009 and 2001 Recessions
1990-1991 and 1981-1982 Recessions

1980 and 1973-1975 Recessions

1969-1970 and 1960-1961 Recessions

Profits and job growth strong? Not anymore.

There were major revisions made over the past few weeks to two measures of the economy that have flown a bit under the radar given the attention devoted to tweets. The first—which I highlighted in my recession report two weeks ago—was the multi-year downward revision to the National Income and Products Account (NIPA) measure of U.S. corporate profits (covering all public and private companies). The ~$200 billion downward revision by the Bureau of Economic Analysis (BEA) was concentrated in the past three years, and resulted in a now-flat trend in corporate profits over the past five years vs. the pre-revision upward trend, as you can see below.

Corporate Profits Flat for Five Years

Corporate Profits Flat for Five Years

The trade war was launched only a few months after corporate tax cuts passed Congress. In our view, the hoped-for surge in capital spending that was expected following the tax cut has been offset by the negative impact of the trade war. It was therefore interesting that another tweet last week referred to the additional tariffs being threatened by the United States as “taxes” (which is frankly what they represent).
More recently, there was a significant preliminary downward revision to non-farm payroll growth from the Bureau of Labor Statistics (BLS). That estimate was a downward revision of 501k to the increase in payrolls for the year that ended in March 2019; with the next annual revision coming in February 2020. As you can see in the chart below, it was a meaningful revision (2.5 million payrolls down to 2.0 million payrolls; a 20% haircut). We assumed an even distribution of the revision across the 12 months to construct the post-revision line. With the revision, payrolls rose by 168k per month instead of the originally-reported 201k.

Significant Downward Revision to Payroll Growth

Significant Downward Revision to Payroll Growth

Markit’s manufacturing PMI moves into contraction territory

Back to the weakness in manufacturing, it was seen within the LEI in ISM new orders as well as the average workweek. The ISM’s release dates back to August 1. Needless to say, a lot has happened since then; so it’s worth looking at the PMIs from Markit, which were released last week, and therefore capture more (although not all) of the latest trade-related uncertainty.
As you can see in the chart below, not only has Markit’s headline manufacturing PMI fallen below the key 50 reading (the demarcation between expansion and contraction), even the services PMI is getting uncomfortably close.

Manufacturing & Services PMIs Weakening

Manufacturing & Services PMIs Weakening

We’ve obviously seen the indirect hit to business (and to a lesser degree consumer) confidence from the trade war. But this dented confidence has had a direct impact on capital spending intentions, which have plunged. There will likely be an increasing direct hit; especially if the currently-threatened higher tariffs are implemented given they are significantly-more consumer oriented. The visuals below show the direct impact on U.S. gross domestic product (GDP) of the already-implemented and prospective tranches of U.S.-declared tariffs on Chinese imports (which are paid by U.S. companies importing goods from China). What it doesn’t (yet) show is the impact on U.S. growth of China’s retaliatory tariffs on goods they import from us.

Estimated Impact of U.S.-Imposed Tariffs on U.S. GDP

Estimated Impact of U.S.-Imposed Tariffs on U.S. GDP

Fed to the rescue?

There are some offsets to the weakening of the growth outlook, including monetary policy. However, although the Fed is likely to continue to lower rates according to the fed funds futures, it’s unlikely the elixir for what ails the economy. In his speech at the Fed’s Jackson Hole confab last Friday, Chair Powell cited, “uncertainty about the recent developments,” and the latest Federal Open Market Committee (FOMC) meeting minutes noted that trade tensions, the global economy and “softness in business investment and manufacturing so far this year [were] seen as pointing to the possibility of a more substantial slowing in economic growth than the staff projected.”

In summing up Powell’s speech last week, he said that the White House and Congress—not the Fed—have primary responsibility for the economy’s trend and that the Fed can only react to keep growth moving within its legislated mandate. The most relevant quote from Powell was this perhaps: “While monetary policy is a powerful tool, it cannot provide a settled rule book for international trade.”


The bottom line is investors, business leaders and consumers have been given a lot to chew on with regard to trade and its impact on the economy. Although the consumer side of the economy has remained resilient, business and capital investment are squarely in the crosshairs of a worsening trade war. That means we need to keep a close eye on the stability in the line that divides the manufacturing and consumer sides of the U.S. economy, wary of any negative manufacturing data bleeding over into consumer weakness.”

Market Update

Investors returned to the markets Monday after a sharp tariff-related decline closed the prior week. Stocks responded well to President Trump’s comments that trade talks with China would be resuming. Those comments sparked a bit of a relief rally, with stocks closing +1.1%. The relief faded Tuesday, however, as the yield curve inverted once again with short-term interest rates rising above longer-term rates (an inverted yield curve has been known as a predictor of recession). Stocks slipped back -0.3%. Strength in oil prices supported stocks Wednesday leading to a +0.6% gain as U.S. investors shrugged off a surprising development in the UK’s Brexit negotiations. UK Prime Minister Johnson received approval to dissolve Parliament, a move that caused a sharp move downward in the UK currency and added to the geopolitical risk investors face. Thursday’s market saw stocks rise solidly to a +1.3% gain on words from China’s Commerce Ministry saying China wouldn’t retaliate to recent U.S. tariffs. That sentiment carried stocks to a strong opening Friday, the last trading day of a turbulent month of August. However, investors were unwilling to increase risk ahead of the long Labor Day weekend, and quickly sold stocks down to a flat finish. Despite the wild and scary swings, the month of August closed down less than -2%.

Stocks snapped their August-long losing streak with the S&P 500 (SPY) rising +2.67% in the final week of the month and closing at the higher end of a month-long trading range. The Nasdaq 100 (QQQ) pushed higher by +2.97%. Small-cap stocks (IWM) lifted +2.34% but remain below their long-term 200-day moving average. We should note small-cap stocks fell just shy of -5% on the month, much worse than their large-cap brethren.

Warm wishes and until next week.