The Week That Was Stormy

Written by Stephen Swanson

A shortened trading week was not affected by economic releases and during the past week we saw a slew of releases generally confirming our picture of stable but anemic growth but with hints of strength in the US and mixed signals from Europe and China and with risks posed by the former growing.

The week opened with the Dallas Fed Regional Manufacturing survey which was then followed by a raft of other PMI surveys including the highly respected ISM-PMI.  According to the Dallas survey, factory activity in Texas increased during the month of October with aggregate index improving from -0.9 in September to +1.8 for the current reporting period. The production index, a key measure of state manufacturing conditions, dipped from 10 to 7.9, indicating slightly slower but positive growth. Overall, the Fed surveys tend to show growing improvement but, in general, remain more contractionary than do national PMI’s.

The Chicago ISM business barometer index, which covers both manufacturing and non-manufacturing, edged up 0.2 percentage points in October to 49.9 but, at the margin, remains in contraction. Business activity measures reflected weakness in five of seven indexes, most notably as the rate of expansion in production and employment slowed while new orders stalled near neutral and order backlogs remained in contraction. The production index slipped to 50.0 in October from 56.5 in September. The new orders index fell below breakeven to 47.0 from 51.0 in September. The latest reading suggests that the economy is just muddling along.

The October Markit PMI index slid to a final reading of 51.0 from 51.1 in September, coming in slightly weaker than the flash estimate of 51.3. Although growing, manufacturing began the fourth quarter weakly. Output increased at the second slowest rate of the past three years, as new order growth lost further momentum. New export business remained a drag on the sector, with a fifth successive monthly decline. Compounding difficulties was a sharper increase in average input prices during the month.

The closely watched Institute for Supply Management’s PMI edged up to 51.7% from an unrevised reading of 51.5% in September and a three-year-low of 49.6% in August. Higher readings for new orders (54.2) and production (52.4) were offset by lower figures for supplier deliveries (49.6), inventories (50.0) and employment (52.1). The Backlog of Orders continued to contract and the separate index of new export orders fell to 48.0, indicating declining exports and remaining near its lowest reading since the recession’s end.  Steve Hansen has an extended analysis of the data.

It’s worth noting that both the Markit and ISM PMI’s observe deteriorating exports but conflict (disagree) on the trends in new orders. This week’s release by the Department of Commerce of the details of its early release on Durable Goods, Shipments and Inventories, however, would tend to support ISM as new orders for manufactured goods did increase in September with headline increases of 4.8%. Excluding the volatile transportation sector, order increases were more subdued at 1.4%. Headlines notwithstanding, the data is soft (see GEI analysis) and orders for capital goods excluding transportations and defense (core capital goods) remained flat while shipments deteriorated.

Orders for core capital goods are frequently viewed as a proxy for future business investment which, for the most part, has been flat in the last reports on GDP. Further, core capital spending has been correlated with business sales. Should orders for core capital goods remain soft, this could pose a serious threat to the economy as some studies (one in particular StreetTalk) suggest the YOY change in the three month moving average of core capital spending has turned negative and could be a harbinger of a recession.  And Moody’s warns:

“Gains in the September durable goods orders report were not enough to accelerate US business sales. Core capital goods orders tightly correlate with sales and investment, and those orders fell 6.5% yearly last quarter — the sharpest decline in almost three years. Such a shortfall has been previously seen only in the throes of a recession. Domestic consumer spending growth may protect the economy from the full brunt of this distressing development, but businesses with international operations will not be as fortunate. When core capital goods orders have shrunk on a yearly basis, business sales growth fell by an average of 3.3%. Core capital goods orders held flat on a monthly basis in September; we must soon see them rise — like last month’s new orders sub-index from the ISM Manufacturing survey — if we are not to see a deepening business sector slump.”

Unlike corporate CEO’s who worry about macro global concerns, it’s fortunate the US consumer is more concerned employment prospects, home values and gasoline prices. Possibly bolstered by modest improvements in employment conditions (more later) and increasing home prices, which edged up 0.5 percent after advancing 0.3 points in August as measured by the 20-city Case Schiller composite index, consumer confidence built upon previous gains in October.

The Conference Board measure of consumer confidence improved in October to a reading of 72.2, up from 68.4 in September. The present situation index increased to 56.2 from 48.7 while expectations climbed to 82.9 from 81.5 last month. While below the consensus estimate of 74.0, consumer confidence is now at its highest level this year.

Consumers were considerably more positive in their assessment of current conditions, with job market improvements as the major driver. Consumers were modestly more upbeat about their financial situation and the short term economic outlook. Consumers’ assessment of current conditions improved in the month. Consumers’ were more positive about the labor market as well with those stating that jobs are plentiful increasing and those claiming jobs are hard to get decreasing.

Consumers were generally more optimistic about the short-term outlook in October. Those anticipating an improvement in business conditions over the next six months increased but so did those expecting business conditions to worsen. Consumers’ outlook for the labor market was also mixed. Those anticipating more jobs in the months ahead increased as did those expecting fewer jobs.

While improved consumer confidence is welcome, it’s important to place it context as it would be easy to mistake months of growing confidence with something that it is not: unbridled enthusiasm. Steve Hansen and Doug Short have gone to some length to show current consumer confidence remains precariously close to levels often associated with recessions and Haver Analytics notes that confidence stands at its 27th percentile in a queue from all measurements taken since 1980. Stated otherwise, the consumer has been more confident 73% of the time since 1980. This tells us where we are and how much further we have to go.

Towards this end, Friday’s employment report will likely be supportive of further gains in consumer confidence. The Department of Labor reported non-farm payrolls grew 171,000 during October following revised gains of 148,000 and 192,000 during the prior two months, earlier reported as 114,000 and 142,000, respectively. Moderate job gains continued in most industries although government payrolls declined. The unemployment rate ticked up to an expected 7.9% from growing participation in the labor force. Employment was strong for a second month and jumped 410,000 as measured in the household survey. ADP had expected the private sector to add 158,000 jobs in October, the first report since ADP changed its methodology.  Two good analysis articles for the new data can be found here and here.

Thursdays report on first time unemployment claims was also constructive showing for the week ending October 27, initial jobless claims fell 9,000 to 363,000 compared to the prior week which was revised up 3,000 from the original 369,000. The four-week moving average was 367,250, a decrease of 1,500 from the previous week’s revised average of 368,750. The four-week moving average a year ago was approximately 450,000. Initial claims are highly correlated with the unemployment rate and inversely correlated with equity prices.  The year-over year improvement in this metric continued.

Coinciding with growing consumer confidence and improving labor market conditions, nominal personal consumption expenditures jumped 0.8% (3.8% y/y) last month, the largest increase in eighteen months. Spending on durable goods increased 1.1% (6.5% y/y), boosted by a 1.4% (8.4% y/y) gain in spending on motor vehicles. Non-durables spending surged 1.7% (4.3% y/y). However, that increase reflected a 5.4% (7.1% y/y) surge in gasoline purchases. Overall, real personal spending grew 0.4% (2.1% y/y) last month while real disposable income remained flat for the fourth consecutive month, reducing the rate of savings to 3.3% from 3.7%. Over the same four month span, the rate of savings has fallen from 4.4% to 3.3%. The issue is obvious: stagnating real incomes can support rising consumption only until savings are exhausted.

The combination of growing consumer confidence, willingness to spend and attractive financing plans can be seen in automobile sales. Sales of total light motor vehicles grew 2.9% in September and hit a new recovery high 14.9 million SAAR for the highest annual rate since March 2008. But then towards the end of the week it was reported that light vehicle sales were under pressure last month. Unit sales of light motor vehicles fell in October 4.4% m/m (+7.2% y/y) to 14.29M (SAAR) according to the Autodata Corporation. Virtually all attributed the sudden fall in sales to hurricane Sandy although some auto executives are quick draw a distinction between improving confidence and a strong economy.

Lastly, it was reported that construction spending rebounded 0.6 percent in September, following a decline of 0.6 percent the prior month. The boost in September was led by a 2.8 percent increase in private residential outlays after a 3.2 percent fall the month before. For the current month, private nonresidential spending slipped 0.1 percent while public outlays decreased 0.8 percent. Residential construction continues to drive construction spending, something which must continue for the economy to maintain its meager momentum.


Following an improvement in the HSBC-Markit PMI for China which increased to 49.5, the official purchasing managers’ index was released and shows a rise in October to a four-month high of 50.2 from 49.8 in September. In edging past that mark, the latest PMI suggests that Chinese factories are getting busier, but just barely.

A slump in the housing sector and weak exports have been drags on China’s growth, but the government has in recent months ramped up spending on infrastructure projects to make up for the shortfall in private spending. And other data releases seem to suggest China’s decline may have been arrested, at least for the time being. Industrial production grew 9.2 per cent from a year earlier, compared with 8.9 per cent growth in August. Fixed asset investment growth accelerated slightly from 20.2 per cent to 20.5 per cent, and retail sales growth jumped from 13.2 per cent to 14.2 per cent growth.


But all observers and analysts caution that resumption of vigorous growth in China is largely dependent upon conditions in Europe which continue to deteriorate. Economic confidence in the euro area fell for the eighth month to the lowest in more than three years in October, adding to signs the slump extended into the fourth quarter. An index of executive and consumer sentiment in the 17- nation euro area dropped to 84.5 from 85.2 in September, that’s the lowest since August 2009.

And in the wake of these releases, Markit released its final PMI for Eurozone manufacturing which came in at 45.4 with demand weak and rates of contraction in output and new orders accelerating. From the report:

The downturn in the Eurozone manufacturing sector extended into a fifteenth successive month in October, as domestic market conditions remained subdued and intra and extra-Eurozone trade flows deteriorated further.

At 45.4 in October, from 46.1 in September, the headline seasonally adjusted Markit Final Eurozone Manufacturing PMI® was slightly above the earlier flash estimate of 45.3.

The downturn not only deepened, but also widened during the latest survey period. Only the Irish PMI stayed above the neutral 50.0 mark, as the Dutch PMI edged back into contraction territory. Rates of contraction accelerated in Germany, Italy, Spain, Austria and Greece. Although the downturn in France eased slightly, it remained stronger than the euro area average.

The renewed and widespread deepening in Eurozone manufacturing activity in October according to the PMI data is both disappointing and worrying. Consequently, it already looks probable that the Eurozone is headed for further economic contraction in the fourth quarter after GDP highly likely fell modestly for a second successive quarter in the third quarter after falling .2% in the second quarter. “Every indicator we’re looking at is headed south for Europe,” Carl Weinberg, chief economist at High Frequency Economics told Kathleen Hays on Bloomberg Radio on Oct. 24. “Europe is headed for an event much more akin to the Great Depression than to any other business cycle we’ve seen in our lives.

On the bright side, the UK reported a positive GDP number indicating that it could be emerging from a double dip recession, if it actually is proven that one even occurred.


And finally, there were reports out of Japan that the Bank of Japan has taken the rare step of easing monetary policy for the second month in a row, conceding that its 1 per cent inflation target would not be reached without more aggressive stimulus. Government data last week showed that consumer prices fell for a fifth consecutive month, while inflation-linked bond markets suggest that inflation will remain below the BoJ’s 1 per cent goal even in 2017. With the latest central bank intervention, the total of all asset purchase plan (APP) interventions will amount to 20% of GDP.

Separate data released on Tuesday showed that industrial production across the country fell for a third straight month in September, recording its biggest fall since last year’s earthquake and tsunami. Persistently weak shipments are the main reason why many economists expect Japan to have entered a recession in the third quarter. Very sobering.


If we were to look only at the US in the context of the week’s data, it might be easy to feel slightly encouraged by improved labor market conditions, increases in consumer spending, increases in consumer confidence and the general tone of manufacturing PMI’s. But when we place these metrics in the context of history or their fragile sustainability, doubts and uncertainties immediately surface. And when we place the US economy in the context of the global economy, these reservations are magnified.

The Eurozone, while mired in a financial crisis, is clearly entering a winter of recession that could be long lasting as most of the economies are sclerotic, burdened by large governments, overwhelmed with measures to protect industries and interest groups, encumbered by large national debts and saddled with largely insolvent banks. Further, to correct excess of the past there is little room to consider expansionary fiscal policies and there are binding political constraints on monetary policy. And lastly, the seventeen countries are part of a monetary union that is taking the most tentative steps towards a fiscal union in which banking and treasury operations would be centralized.

If the EMU is to survive it must take these steps but to do so will require relinquishing much sovereignty and control to an unelected bureaucratic body likely to be located in Brussels. There will be both political and popular opposition to this, meaning it will take a very long time to effect- maybe something like ten years. In the meantime misguided policies are being enforced and doing more harm than good. Rather than adding more debt and pursuing indiscriminate austerity, the EU should be forcing countries in need to restructure dysfunctional economies to make them more competitive with the incentive of assisting with debt reduction.

And everything takes so long to complete. After two years Greece has still not passed the needed legislation to privatize sate assets; the architecture for a central bank will not be available until the end of this year and its implementation (excluding deposit guarantees and resolution authority) is scheduled for “sometime” in 2013; Spain continues to dither while postponing the inevitable application for assistance; and the talks between Greece and the troika go on, well, endlessly.

Given this backdrop and the vacuum of available policy responses, how will the EMU escape a recession of indefinite duration? And what will be the amplitude and duration of the contraction?

These are important questions on their own but rise in significance when it’s recognized that Japan is on the edge of a similar fate thereby calling into question something close to 26% of the world’s economy. Advanced industrial economies would be unable to escape contagion as too many linkages exist through trade, markets and capital flows. And this is why Gary Schilling has reduced his estimate for operating earnings for the next four quarters to $80, about 20% below prevailing estimates. He sees recession-induced reductions in profits, margin compression and exchange losses on the back of a stronger dollar.

It’s hard for your humble analyst to offer much cheer.

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Analysis and Opinion Articles by Stephen Swanson

About the Author

CautiousInvestorStephen Swanson has a degree in economics and an MBA. His corporate experience includes several executive positions including a divisional VP assignment. More recently he has left the corporate world and has been investing in financial instruments and real estate, with interests expanding into S&P futures and commodities. Stephen is known on the internet under the pseudo nom CautiousInvestor and is a frequent commentator at Seeking Alpha where he also posts blogs.

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