Recession! While I’m relatively certain it will come as a surprise to many, the stock market has been telling us it’s a near certainty for more than a month now. Economic data has been foreboding of it through two-thirds of the third quarter, and September has only just started.
After Washington and Standard & Poor’s shocked the market in July and August, the latest measure of investor sentiment showed a significant loss of faith. Finally, despite the latest consumer spending data, consumer sentiment measures are telling us Americans are probably not spending like they might have otherwise. Certainly on a real basis, they’re not anyway.
Without consumer discretionary spending, and if the American shopper has played it tighter to the belt through the important “back to school” shopping season, well, it seems plainly clear to me, recession is a near certainty for Q3.
The earliest signs came in the form of manufacturing data. The Institute for Supply Management (ISM) reported that its Purchasing Managers Index dropped to 50.9% in July, down from 55.3 in June. More importantly, the index was just short of indicating a recessionary environment for the manufacturing sector. ISM’s New Orders Index component, an obviously forward looking metric, did fall below that important threshold, to 49.2. With August just reported, ISM’s manufacturing measure drifted ever more closely to its break-point, down to 50.6%, with the New Orders Index sticking below 50 at 49.6.
More recently, we’ve seen the Philadelphia Fed’s Diffusion Index of Current Activity dip into negative territory twice over three months. In fact, in August the index dropped to -30.7, the lowest it has been since March of 2009. You remember March of 2009, when the world seemed to be coming to an end and no investment seemed like a good idea. It was the month the market bottomed and all asset correlations moved to 1.0.
Q2 productivity was revised lower to -0.7% against Q1, from the initially reported -0.3%. The funny thing about the Productivity data though, was that the downward revision was not due to the manufacturing sector. It was instead driven by business level deterioration, as the business segment dropped -0.5%, versus the initially reported flat line, pun intended. The deterioration seen in manufacturing actually improved to minus 1.5%, versus the initially reported decline of 2.0%.
We saw Factory Orders increase 0.9% in July, excluding transportation. That was a pleasant change after June’s 0.4% increase, excluding transportation. Within my article on the report, though, I exposed the fact that there were a good many industries, if not a majority, showing declines in factory orders. It seemed to me that strength in a few industries pulled up total activity, and I suspect those particular industries benefited from Japanese rebuilding demand. Primary metals, for instance, were a strong gainer. If this demand was driven by emerging market needs, well then we still raise alarm, as the pace of growth has been slowing even in the hot markets of India and China. And certainly Europe is not stable. Within our write-up, we noted important declines in computer and electronic products, industrial machinery, and electrical equipment and appliances. That is not good news from factory orders.
The deterioration in consumer confidence has been well documented, but the warning it offers has not been heeded by the popular press. It has, however, been well noted by the stock market. We saw some startling data regarding the health of consumers recently. The Conference Board said its Consumer Confidence Index plummeted in August to 44.5, down from 59.2 in July. The Board’s Present Situation Index already reflected a dismal state of affairs, but it dropped in August to 33.3, from 35.7. While many point to consumer actions defying sentiment measures in the past, what the report says to me is that consumers are tightening their belts, especially since the Expectations Index fell precipitously to 51.9, from 74.9. This reflects the consumer view for the next six months, and it illustrates a situation where consumers are unlikely to spend freely due to concern for cash stores and their employment.
Indeed, other data is confirming that consumers are pulling back, despite the Personal Income & Outlays Report for July showing a 0.8% increase in spending. What readers of that report should note is that real spending, thus taking inflation into account, rose a lesser 0.5%. And let’s remember that we have measured July here, with August yet to come. Recent weekly same-store sales data from the International Council of Shopping Centers (ICSC) has had year-over-year growth at 3.0%, which is not impressive when taking inflation into account. The weekly comparisons have been negative to flat, and that’s an indicator to me of economic contraction.
What Washington’s debt debacle debate and the S&P downgrade have basically accomplished is to freeze consumers, investors, purchasing managers and hiring managers. Uncertainty now rules the day, and uncertainty holds up economic growth. The latest Employment Report showed an August nonfarm payroll net change of zero, with the unemployment rate holding at 9.1%. Challenger, Gray & Christmas reported that announced corporate layoffs were relatively high for a second consecutive month. Weekly Jobless Claims have been edging higher of late, as evidenced by rise in the four-week moving average. Claims have held above the 400K mark for several weeks. It’s a labor situation that spells trouble, as it reflects uncertainty in the minds of employers, which has only been solidified by the consumer and investor moods.
All hope is now clearly focused on President Obama and an unbalanced, counter-productive balanced government. My feeling is that whatever the poor President proposes this week, the Republican Party will reject, or at least dilute or delay. This is clear by the change of mindset from a spend-free GOP when the party controlled government, to a sudden state of budget righteousness at precisely the wrong time for it. Politics are unfortunately getting in the way of the work we send politicians to do for the people. As far as the Federal Reserve Chief and his well-heralded two-day FOMC meeting this month go, he is facing resistance and seemingly only succeeding in undermining our currency anyway.
When the market first started lower, I noted a trend of upgrades by stock analysts, drooling over target prices that seemed to offer richer capital gain opportunity. However, that's only because they had not received the revised forecasts of their in-house economists and strategists yet. You know, the sort we've gotten of late from J.P. Morgan Chase (NYSE: JPM), Goldman Sachs (NYSE: GS) and HSBC (NYSE: HBC). Lately, I'm seeing a mix of stock downgrades with upgrades of cyclical and high-beta stocks, perhaps reflecting this trickle-down. Credit Suisse (NYSE: CS) even cut its forecasts for Goldman and Morgan Stanley (NYSE: MS) recently. Goldman just cut its forecast for cyclical sectors aluminum and homebuilding. In my opinion, Warren Buffett was recently called to support the capital position of Bank of America (NYSE: BAC), providing the same kind of financing he did during the financial crisis. Indeed, all does not appear well to me. The broader market action of August seemed to clearly forewarn of recession, as the market regularly precedes the economy.
Thus, with two months of distress behind us, and this month unlikely to miraculously change trend, I see economic recession as probable, with contraction threatening to arrive in this coming third quarter. Recession is defined by two consecutive quarters of economic contraction, so it is impossible for Q3. Economic contraction only represents a lower level of economic activity than the immediately preceding quarter. I do not think that is such a stretch for the near future, considering the case I have just laid out.
Thus, the third quarter seems it may make for a good start toward what I would call a dead cat bounce recession. That is because a double-dip recession is now impossible as well, but due to the depth of the last recession and the inevitable recovery from that unsustainable panic driven low level of economic activity, our economy has bounced sort of like a dead cat might. I spoke about this in the early days of economic recovery at my blog, and it appears to now be playing out. We’ve basically found a higher stall, and with global markets also troubled, the dead cat thud may cometh.