What the Fed Did Not Say
The annoying truth that very few economists want to admit is that the field is more art than science – much like investing. If investing were as easy as simply looking at the past and extrapolating it forward, you’d not need us. When it comes to econ
omics, the best we can do is to develop an idea of general future probabilities based on how events unfolded in the past.
The headlines have been heralding all kinds of economic triumphs lately, which has been giving yours truly much brow furrowing consternation; talk about heads in the sand! Let me walk you through what no one seems else seems to be talking about.
One: Q1 GDP has been revised into a contraction, falling 0.7%. It is important to note that this is the first time in recorded US economic data that the economy has contracted three times during a recovery. That seems like a noteworthy lack of strength, particularly given all the support the Federal Reserve has been supplying coupled with the mindboggling level of federal spending; recall that during the last seven years US debt has doubled, meaning the government overspent as much in the past 7 years as it did in the entire 230 years prior combined!
Two: June 15th we learned that Capacity Utilization for total industry in the United States fell for the sixth month in a row. This is measured by the Federal Reserve and represents, “the percentage of resources used by corporations and factories to produce goods in manufacturing, mining, and electric and gas utilities for all facilities located in the United States (excluding those in U.S. territories). This measure has fallen six months in a row ten times previously since 1967, the earliest recorded data. Every single time it has fallen in the past six times in a row, the economy has been in a recession. In fact, the economy has never been in a recession when the metric did not fall for at least six consecutive months. Think of it this way, the US economy has thrown a big old production party, but hardly anyone’s on the dance floor and everyone’s wondering when the crowd is finally going to arrive.
Three: Industrial Production has now come in below expectations six months in a row, and has shown a rather concerning downward trend since January. Keep in mind that a contraction in GDP for two quarters in a row, i.e. six months, is the definition of a recession. Industrial Production used to be the metric for the economy before GDP started being measured after WWII. May’s number is also a bit of a blow to the hopes for a turnaround to GDP in Q2, as the level of production so far in Q2 is down 2.4% at an annual rate relative to the average for Q1, which was itself down 0.3% from Q4 2014. This means we are likely to see the first back-to-back quarterly contraction in production since Q1 and Q2 of 2009. Were this pre-WWII, this data mean an official declaration of a recession.
Four: The three month moving average for US retail sales is at a level that is never seen outside of a recession, hat tip to Raoul Pal of Real Vision Television, (which I highly recommend for on-demand interviews with the best and brightest in the markets) for pointing out this one to me. While May retail sales were up from April, they were still 25% below March with an overall trend downward trend that is clear in the chart. So much for the return of the American consumer… not just yet.
Five: The talking heads on TV claimed that the contraction in Q1 was due to extreme weather conditions and the port closures/slowdowns due to the labor union kerfuffle on the west coast. First quarter earnings releases and analyst calls where abuzz with retail executive bemoaning the lost sales thanks to goods getting stuck at the west coast ports. Alrighty then… we were willing to give them some wiggle room here. However, the port situation was resolved some months ago, which should have led to a big jump up in transportation needs within the US to get goods to and from those congested ports. Errrh….. May… not looking so good. That phrase is starting to sound like Wall Street speak for, “The dog ate my homework.”
Not exactly inspirational; not only has rail traffic in 2015 been materially lower overall than in 2014, but May saw a sizeable decline both relative to April and to May 2014. This data is reinforced by the Cass Freight Shipping data, which was released on June 15th, showing that while shipments and expenditures rose in May from April, they are still below 2014 levels, which was the strongest year so far since the Great Recession. Both car-loadings and intermodal-loadings were declining by month’s end as well, indicating that June is likely to also be weak.
To emphasize the point with transports, earlier this week Federal Express delivered quarterly earnings and revenue that fell short of expectations, citing pension costs, the impact of the strong dollar and lower fuel surcharges. All reasonable claims except they are nothing new, thus the company’s guidance should have already taken those factors into account. To us this just gives further reason for concern.
Six: For all the talk about how the labor markets are heating up, getting tighter… whatever lovely catch phrase you like, June 18th the Labor of Bureau Statistics announced that real average hourly earnings decreased by 0.1% in May, seasonally adjusted. Real average weekly earnings also decreased by 0.1%. So much for all the talk about tightening labor markets inducing inflation, I keep scratching my head wondering what the heck the talking heads are looking at! On top of that, a recent report from Glassdoor Inc. revealed that job seekers had to wait about 22.9 days for an offer or rejection in 2014, up from 12.6 days in 2010 – again not an indicator of a tight job market.
To drive the point home, the chart below shows just how much of the incoming data has surprised to the downside. Does this mean that expectations are entirely out of whack with reality or does it mean that the economy is weakening? Well, putting it all together…
Bottom Line: As I said earlier, economics and investing involve looking at the new data coming in, comparing it to earlier data and looking for correlations in an attempt to identify trends or causation. In other words, we seek to understand what’s going on now, what’s causing it and where are we going? The current recovery has stumbled an unprecedented three times into contraction, which gives concrete data on how week this recovery actually has been. Capacity utilization, Industrial Production and Retail Sales data all point to a recession. Transportation of goods is well below last year and not showing signs of improvement and if one looks under the covers of the labor market – it is much weaker than the headlines indicate. One of our primary jobs is to manage risk and when we put all that data together, it gives us cause for concern as to the direction of the economy. The chart below indicates that we aren’t the only ones noticing just how weak the economy has become, as executives increasingly decide to return money to shareholders directly rather than invest it in elusive future growth.
