Recessions are notoriously difficult to measure (even the NBER occasionally gets it wrong) and an official declaration of a recession may be lagged by more than 6 months. Economist Claudia Sahm uses the following rule as a timely indicator of recessions:
Corporate profits (before tax) ticked up slightly in the second quarter of 2019 but remain below 2006 levels in real terms. The chart below shows corporate profits adjusted for inflation using the GDP implicit price deflator.
Growth in production of durable consumer goods remains week, reflecting poor consumer confidence.
The chart below shows growth in bank credit and the broad money supply (MZM plus time deposits). Credit growth (blue) remains steady at around 5%, slightly ahead of nominal GDP growth (4.04% for 12 months ending June); a healthy sign. Broad money (green) surged upwards in the first three quarters of this year. Not an encouraging sign when there were similar surges in broad money before the last two recessions.
The S&P 500 is testing resistance at 3000. Bearish divergence on Twiggs Money Flow warns of secondary selling pressure. Expect a test of support at 2800. Breach would flag a reversal, with a target of 2400.
The cyclical Retailing Index displays a similar pattern, with resistance between 2450 and 2500.
Our view is that upside is limited, while downside risks are growing.
On the global front, the outlook is still dominated by the prospect of a prolonged US-China trade war. More great insights from Trivium China:
Tariff delays may be aimed at creating warm, fuzzy feelings before the next round of talks in early October, but……These small gestures do nothing to resolve the underlying trade conflict. We’re still pessimistic on prospects for a deal.
Zhou Xiaoming – China’s former top diplomat in Geneva – expressed the same view in a recent interview (Guancha):
“The two sides disagree too much on the objectives of the negotiations……It is almost impossible to reach an agreement in the short term.”Zhou urged Chinese officials to be clear on the US’s objective:
“Economic and technological decoupling is the objective of the entire US government.”Zhou said that officials must prepare for that potentiality, even if it is not their desired outcome.
So should we.
Dow Jones – UBS Commodity Index found support at 76 before rallying to 79. Rising troughs on the Trend Index reflect increased support. Consolidation between 76 and 81 is likely but we maintain our bearish long-term outlook for commodities.
On the global front, weak crude oil prices flag an anticipated slow-down in the global economy. Trend Index peaks below zero indicate selling pressure. Breach of support at $50/$51 per barrel would be a strong bear signal, warning of a decline to $40 per barrel.
We maintain our investment in quality growth stocks but have reduced equity exposure to 40% of (International Growth) portfolio value.
Reuters says that export orders are falling and the contraction is expected to worsen in coming months:
Beijing is widely expected to announce more support measures in coming weeks to avert the risk of a sharper economic slowdown as the United States ratchets up trade pressure……
On Friday, the central bank cut banks’ reserve requirements (RRR) for a seventh time since early 2018 to free up more funds for lending, days after a cabinet meeting signaled that more policy loosening may be imminent.
August exports fell 1% from a year earlier, the biggest fall since June, when it fell 1.3%, customs data showed on Sunday. Analysts had expected a 2.0% rise in a Reuters poll after July’s 3.3% gain.
That’s despite analyst expectations that a falling yuan would offset some cost pressure and looming tariffs may have prompted some Chinese exporters to bring forward or “front-load” U.S.-bound shipments into August, a trend seen earlier in the trade dispute…..
Among its major trade partners, China’s August exports to the United States fell 16% year-on-year, slowing sharply from a decline of 6.5% in July. Imports from America slumped 22.4%.
Many analysts expect export growth to slow further in coming months, as evidenced by worsening export orders in both official and private factory surveys. More U.S. tariff measures will take effect on Oct. 1 and Dec. 15.
Banks are suffering a liquidity squeeze:
The PBoC says the new cuts will release RMB 900 billion of liquidity. That’s more than the RMB 800 billion and RMB 280 billion released by the January and May cuts, respectively. (Trivium China)
Consumer confidence is ebbing.
China’s response to tariffs has annoyed the Trump administration, making prospects of a trade deal even more remote.
China’s response to U.S. trade actions appears to reflect a cynicism about the efficacy of democracy. Beijing’s strategy appears calibrated to exploit the fact that the American people elect the head of their government, by attempting to influence how the American people will vote. In effect, it seems to be gambling on its ability to turn American democracy against itself.
At the center of China’s responses are the tit-for-tat tariffs intended to hurt American farmers, a constituency that tends to support President Donald Trump and to live in crucial swing states. These tariffs appear designed to deliver political pain in the U.S., not to produce any economic benefit for China. China’s other political meddling, as Vice President Mike Pence recently laid out, includes attempts at interference in the 2018 U.S. midterm elections. Recent targets of Chinese Communist Party influence campaigns also include state and local governments, Congress, academia, think tanks, and the business community. (The Atlantic)
A massive increase in stimulus is the likely eventual outcome, focused on housing and infrastructure. That would fuel demand for raw materials such as iron and steel.
If not, expect a sharp drop in imports to impact on China’s major trading partners.
Bob Doll at Nuveen says he does not expect a recession (for the next few quarters) but remains neutral towards stocks:
“Although stock prices have advanced over the last couple of weeks, investors remain focused on downside economic and policy risks and are increasingly concerned about a possible recession. The latest manufacturing readings hurt economic sentiment, while trade issues, turmoil in Hong Kong, the increasing likelihood of a messy, no-deal Brexit and a downturn in European growth are increasing worries.”
The Institute for Supply Management August Report points to an economic slow-down, with the Purchasing Managers’ Index (PMI) falling to 49.1 percent, from 51.2 percent in July. The New Orders Index also declined, to 47.2 percent from 50.8 percent in July. Readings below 50 indicate contraction.
“…The 2020 U.S. elections linger in the backdrop, offering potential to produce either a dramatic shift in economic policy should the Democrats retake the White House, or continued policy uncertainty should President Trump win reelection.
Against this backdrop, investors are struggling to position their portfolios. Consensus appears to say that it is time to turn more defensive, but U.S. Treasuries and other government bond yields appear to offer little if any value. Indeed, government bond markets are pricing in a high likelihood of a recession and a prolonged period of sluggish growth. At the same time, equity markets have been range bound over the last several months (and, by some measures, since the start of 2018) and are providing unclear signals.
In our view, the preponderance of the evidence suggests that growth will remain sluggish but a recession will be avoided, at least for the next few quarters. In other words, we think the signals coming from the equity markets are more accurate than those coming from government bond markets. Nevertheless, we continue to have a broadly neutral view toward stocks, and think investors should remain selective, focusing on such themes as companies that offer compelling value and those that have the ability to put relatively high levels of free cash flow to work.”
The wild card is the impact that high levels of uncertainty may have on business investment and employment.
This is a time to be defensive.
Bonds, traditional dividend-paying blue chips, and growth stocks all appear over-priced at current levels. Small caps are high risk in the current volatile environment and we are focused on large cap stocks with strong cash flows and defensible market position in non-cyclical industries. Some cyclical sectors may present value but investors need to be selective because of vulnerability to a potential down-turn.
August labor stats, released today, point to low real GDP growth for Q3. Growth in weekly hours worked came in at a low 1.09% and GDP is likely to follow.
While inflation is not the primary concern at the Fed right now, rising annual hourly wage rate growth (3.46% for total private) flags an increase in underlying inflationary pressure. This may make the Fed more hesitant about cutting rates despite Donald Trump’s tweet storm.
Most important is the continued decline in annual payroll growth. At 1.38% for August, further weakness is likely and a fall below 1.0% would warn of an economic slow-down.
The S&P 500 is headed for another test of resistance at 3000. The Trend Index oscillating above zero for the last 9 months indicates buying pressure but I expect strong resistance at 3000. Upside is limited while downside risks are expanding.
Semiconductors are doing better than expected, despite the trade war, but I suspect will weaken when the surge in orders ahead of tariffs tails off.
Retail has stalled since late 2018 and bearish divergence on the Trend Index suggests selling pressure.
Automobiles, in a decline since 2017, have rallied over the last 6 months. But, again, further weakness is expected.
On the global front, weak crude oil prices flag an anticipated slow-down in the global economy. Breach of support at $50/$51 per barrel would be a strong bear signal, warning of a decline to $40 per barrel.
We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value.
June quarter real GDP growth slowed to an annual 1.4%, the lowest since the 2008 global financial crisis (GFC). Major contributors to growth are household consumption, public demand and exports; while the biggest handbrake is investment.
A quick look at the RBA chart shows that consumption is slowing but at a slower rate than disposable income. Households are dipping into savings to support consumption, with the savings ratio (savings/disposable income) declining to near GFC lows.
Gerard Minack warned of the danger that households will dramatically increase savings, and cut consumption, if employment prospects grow cloudy.
That brings us back to investment. Low investment is a drag on employment growth.
Low interest rates, on the other hand, are a tailwind at present. They seem to have shored up housing prices,
And states are taking advantage of ultra-low interest rates to boost infrastructure spending.
But low interest rates are a double-edged sword. Bank net interest margins are under pressure.
And credit growth is plunging.
The housing recovery will be short-lived if there is not a dramatic increase in loan approvals.
AMP chief economist Shane Oliver believes that:
“growth will remain soft and that the RBA will have to provide more stimulus – by taking the cash rate to around 0.5% and possibly consider unconventional monetary policy like quantitative easing. Ideally the latter should be combined with fiscal stimulus which would be fairer and more effective. While Australian growth is going through a rough patch with likely further to go, recession remains unlikely barring a significant global downturn.”
But that ignores two factors:
China’s economic model is built on a shaky foundation and trade war with the US is likely to expose the flaws.
Chinese leaders are growing increasingly worried about the economy. Premier Li Keqiang said at this week’s State Council meeting:
“The current external environment is increasingly complex and grim.
….Downward pressure on the domestic economy has increased.”
(Trivium)
BEIJING, Sept. 5 (Xinhua) — Chinese and U.S. chief trade negotiators agreed on Thursday to jointly take concrete actions to create favorable conditions for further consultations in October.
The agreement was reached in a phone conversation Chinese Vice Premier Liu He, also a member of the Political Bureau of the Communist Party of China Central Committee and chief of the Chinese side of the China-U.S. comprehensive economic dialogue, held upon invitation with U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin. (Xinhua)
…Extend and pretend. Neither side wants a full-blown trade war. But they are miles away from an agreement.
Donald Amstad from Aberdeen Standard Investments: “the developed world is verging on catastrophe…. we are facing an unprecedented bust in risk-free (bond) markets.”
Hat tip to Marcus Padley
Treasury yields continue to fall, with the 10-Year testing long-term lows at 1.50%. A sign that investors are growing increasingly risk averse.
Crude oil prices remain weak; a bearish signal for the global economy. Breach of support at $50/$51 per barrel would warn of a decline to $40.
Volatility (21-Day) above 1.0% on the S&P 500 is flashing an amber warning. Breakout above 2940 is likely and would signal another test of 3000. But expect stubborn resistance at our 3000 target level.
Bearish divergence (13-Trend Index) on the Nasdaq 100 warns of secondary selling pressure. Breach of 7400 would warn of a test of primary support at 7000.
Robert Shiller maintains that Donald Trump is unlikely to survive a recession:
“So far, with his flashy lifestyle, the US president has been a resounding inspiration to many consumers and investors. But his personal narrative is unlikely to survive an economic downturn….the end of confidence in Trump’s narrative is likely to be associated with a recession.
During a recession, people pull back and reassess their views. Consumers spend less, avoiding purchases that can be postponed: a new car, home renovations, and expensive vacations. Businesses spend less on new factories and equipment, and put off hiring. They don’t have to explain their ultimate reasons for doing this. Their gut feelings and emotions can be enough.”
I would go further and argue that Trump’s management style is likely to cause a recession.
Some of the aims the President is attempting, like addressing China’s unfair trade practices, are vitally important to long-term US interests and he should be given credit for tackling them. But his constant hyperbole, erratic behavior, with a constant mix of bouquets and brickbats, and on-again-off-again tactics, has elevated global uncertainty. Consumers are likely to increase savings and cut back on expenditure, while corporations may cut back on hiring and new investment, which could tip the economy into recession.
GDP growth contracted to 2.3% in the second quarter, while growth in hours worked contracted to 0.92% for the year ended July 2019, pointing to further falls in GDP growth for the third quarter.
August employment figures are due for release next week and will either confirm or allay our fears.
We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value.
Australian building approvals for July 2019 show a sharply contracting economy. Housing approvals fell by 16.6% on a year-on-year basis and are approaching the 8000 level breached in earlier crashes.
Approvals for apartments (dwellings excluding houses) plunged by a massive 44.2% year-on-year.
The massive contraction in approvals is likely to impact on construction work in the months ahead. Unless we see a similar spike in public sector spending to the 2008/2009 global financial crisis, we are likely to experience a similar contraction to 1988-1990 or 2000-2001. Cutting interest rates, as RBA governor Phil Lowe has repeatedly warned, is not enough.
Unfortunately infrastructure spending in 2008/2009 was not particularly well-directed, increasing public debt without corresponding productive assets to show for it. The NBN has had a few teething problems but made a lot more sense than the school halls and pink batts programs: it produces income (or can be sold) to offset the impact of the debt.
Construction contributes about 15% of national GDP and a sharp downturn could bring us precariously close to negative GDP growth.
The boost from bulk commodity prices is fading, with iron ore edging downwards after a sharp fall. This is a continuation pattern and we expect the decline to continue, with a short-term target of $80/tonne.
We also retain our bearish outlook for the financial sector. Banks face headwinds from falling new housing starts as well as from narrow margins as the RBA cuts interest rates in an effort to stimulate the economy. Expect another test of primary support at 5400.
The ASX 200 is testing resistance at its 2007 high of 6800. A rising Trend Index signals buying pressure but we remain cautious because of the headwinds facing the domestic and global economies.
We maintain a low exposure to Australian equities, at 20% of portfolio value, because of our bearish outlook.
Bob Doll’s outlook this week at Nuveen Investments is less bearish than my own:
Trade-related risks seem to be growing. President Trump looks to be holding out hope that the U.S. economy will stay resilient in the face of escalating tariffs and rising tensions. So far, the U.S. economy has not faltered, thanks largely to continued strength in the consumer sector and labor market. But if business confidence crumbles (as it has in parts of Europe), it could lead to serious economic damage…..
The president’s recent actions to delay the implementation of some new tariffs show that he is sensitive to the market impact of his trade policies. But the erratic nature of his on-again, off-again approach adds too policy uncertainty. At this point, we can’t predict the ultimate economic impact from these issues. Our best guess is that the U.S. remains more than a year away from the next recession, but risks are rising. In addition to the solid consumer sector, we don’t see financial stress in the system. Liquidity is still broadly available, and fixed income credit spreads are generally stable outside of the energy sector.
With additional Federal Reserve rate cuts already priced into the markets and bond yields falling sharply, the only catalyst for better equity market performance could be improving global economic data. We hold out hope that the global economy will improve, and still think there is a better-than-even chance of manufacturing activity and export levels to grow. But those improvements will take some time, suggesting equities will remain volatile and vulnerable for now.
Where we seem to differ is on the inevitability of the US-China trade war escalating into full-blown disengagement. This week’s events have not helped.
China’s national English language newspaper, Global Times, under the People’s Daily, announced new tariffs.
Followed by an admission that the timing of the announcement was intended to cause maximum disruption to US stock markets.
The inevitable Twitter tantrum ensued.
The President also tweeted “Now the Fed can show their stuff!”
He is deluded if he thinks that the Fed can help him here. The best response would be announcement of a major infrastructure program (not a wall on the Mexican border). Otherwise business confidence will decline due to the increased uncertainty. Business investment will contract as a result and slow employment growth.
Retail sales have shown signs of recovery in recent months but will decline if consumer confidence erodes.
Especially consumer durables such as light motor vehicles and housing.
The global economy is already contracting, as indicated by falling crude oil
…and commodity prices.
Volatility (21-Day) is rising as the S&P 500 tests support at 2840. Breach is likely and would test primary support at 2750.
Bearish divergence (13-Week Money Flow) on both the S&P 500 and Nasdaq 100 (below) warn of selling pressure. The Nasdaq 100 is likely to test primary support at 7000.
The Russell 2000 Small Caps ETF (IWM) is testing primary support at 146. Follow through below 145 is likely and would signal a primary down-trend.
Fedex breach of support at 150 would also warn of a primary down-trend and slowing activity in the US economy.
We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value because of elevated risk in the global economy.
