Analyzing a Week That Was No Fourth of July Celebration

Written by Stephen Swanson

The outlook for the global economy and the US, in particular, darkened considerably this past week and occasioned many to write-down their estimates for US and global economic growth while global central bankers loosened monetary policy on the back of the Federal Reserve extending “Twist” in a seemingly coordinated attempt to arrest further declines in output and employment.

Click on photo for larger picture of an economic analyst at work.

U.S. Following the World?

The moves by the bank of England, China and the ECB follow a spate of slowing or contracting global PMI’s punctuated by a rather rapid deterioration in the closely watched US ISM-PMI manufacturing index which plunged to 49.7 from May’s reading of 53.5, in no small part because new orders dropped to 47.8 from 60.1. This decline was largely attributable to falling exports and indicated a decline in new orders for the first time since April 2009. Prior to this there were divergences between many of the regional Fed surveys and the ISM-PMI manufacturing index, but now we are seeing disturbing convergence to the downside. Expected data from China will likely reinforce this trend.

On Thursday the ISM released its services index which dropped to a reading of 52.1% in June from 53.7% in May, the lowest reading since January, 2010. Also on Thursday we learned same store sales increased .1% YoY, while unemployment claims remain essentially unchanged at unacceptably elevated levels. The retail sales report aligns with recent consumer spending reports showing stagnation and eroding consumer confidence readings, which together suggest restraint amid doubt and uncertainty. And the benefits of lower gasoline prices are being saved, not spent.

U.S. Unemployment Woes Continue

On Friday we had another horrible jobs report in conformity with the ISM-PMI manufacturing index and the previously released Philly Fed report.  Employers added 80,000 jobs in the month of June while the unemployment rate remained unchanged at 8.2%. Since the great recession, we have recovered only 50% of the 8 million jobs lost

But during this time the population and the potential workforce has grown.  In the past year employment has increased by around 3 million, while the broadest measure of the civilian potential workforce determined by BLS household surveys has grown by 3.7 million.  Current employment increases are not recovering all jobs lost during the great recession nor are they absorbing population growth, leading to structural unemployment and falling labor force participation rates.

Will Construction Come to the Rescue?

The one solid report came out Monday when construction spending was released and showed an increase 0.9% over May, with strength in residential construction and declines in non-residential and government construction spending. Firmness in residential construction spending is in line with recent strength in new home starts but at odds with a decline in multi-family starts.

Is Manufacturing Wobbling or Steadying?

On Tuesday we learned factory orders rebounded 0.7 percent in May, reversing April’s revised 0.7 percent decline but still well short of reversing March’s 2.1 percent plunge.

Summit Produces Buyers Remorse

Across the pond in Europe the euro fell and yields on Spain and Italy debt rose, giving back all of the gains arising from the 19th EU summit as doubts about the new package and its implementation surfaced. As I suspected, the turn of events suggests that the brief rally that propped up European financial markets in the wake of last week’s summit was no more than a fleeting interlude in the crisis and time-frames may already be slipping amid political wrangling and growing popular national opposition.

A litany of problems are lined up in Europe:

  • It’s not clear Spain has satisfied the conditions essential to receiving bank bail-out funds and EMU finance ministers are meeting Monday aiming to reach a political agreement on the terms of a bailout of up to €100 billion for Spain to recapitalize its teetering banks;
  • The German Constitutional Court is to hear arguments and decide the legal challenges to the ESM;
  • Euro officials have acknowledged that “the turning point in resolving the crisis” is no more and that rescue funds will continue to be channeled through sovereigns rather than recapitalizing banks directly until some remote point in the future when a fully functional banking union is in place;
  • Sovereigns will continue as guarantors of monies borrowed from rescue vehicles, keeping in tact the vicious link between weak sovereigns and weak national banks;
  • The ESM may not be up and running until late 2013 or 2014;
  • Finland and Holland are threatening to veto bond purchases by the ESM even though it’s provided for in the ESM treaty with an 85% majority;
  • Finland is threatening to leave the EMU; and
  • A spate of lawsuits in Spain, with Bankia and its former boss st the center, could further complicate efforts to clean up and consolidate Spain’s banking sector.

A rather fractious union.

The Outlook is for Continuing Slowdown in Europe

Meanwhile the economies (many of which are dysfunctional) of the EMU continue to deteriorate. Private-sector activity across the 17-nation euro zone continued to contract sharply in June but at a somewhat slower pace than in May. The composite Markit index rose to 46.4 from 46.0 in May and is believed to be consistent with economic contraction of 0.6% while a measure of the region’s factories held at 45.1 revealing manufacturing in the EMU is weaker than anywhere else in the world.

Worryingly, there were clear signs that Germany is also entering a modest downturn as its services sector unexpectedly stagnated in June with its PMI reading fell to its lowest since September last year. Germany may be falling into a decline just as Euro area unemployment reached the highest on record in May, inching up to 11.1%.

…And the Rest of the World

In response to these troubling events across the globe the IMF said it would reduce its estimate of global growth from 3.5% to a lower rate yet to be released. Days earlier it fractionally reduced its estimate of US growth in 2012 to 2.0% due to Euro strains and uncertainty over fiscal policies. At the same time Goldman said the current ISM-PMI manufacturing index is consistent with growth of 1.6% and several real time tracking measures suggest the economy is growing at 1.5%.

I think it could easily be lower because auto sales, which contributed 1.1 points of 1.9 points of growth in the second quarter, will be lower in the second quarter than in the first meaning the 1.1 will be erased, possibly turning negative but at best leaving .8 points of growth. Construction spending and business investment could augment this but any increase would be marginal and easily offset by an expanding trade deficit despite lower oil prices.

As to recession or its likelihood, I tend to agree with the EEI (Econintersect Economic Index) which counts “things” that have shown to be indicative of direction of the Main Street economy at least 30 days in the future and which does not “see” a recession within the next month or two. Other measures to watch include the CFNAI (Chicago Fed) index, which is approaching recession levels and efforts by Recession Alert using variants of ECRI data that places the probability of recession within three to four months at around 30%.  At the extreme, George Vrba, a Recession Alert collaborator, believes a recession is at hand using reconfigured ECRI data even though ECRI data continues to marginally improve.  And ECRI continues to support its oft mentioned call for a recession.

Conclusion:  Uncertainty

Who knows? What we do know is the global economy is slowing, the US economy is showing every sign of decelerating, the US economy remains extremely fragile, it remains subject to shocks and is unlikely to be saved by housing which many are pinning their hopes on. Were this not enough, we are awash in political and economic uncertainty and are approaching a “fiscal cliff” of expiring tax cuts and mandatory spending cuts at a time of unprecedented ideological divisiveness.  Lastly, the effectiveness of monetary policy and further easing is in serious question.

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About the Author

Stephen 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.