Richard Berner on Deteriorating Business Conditions

by: Richard Berner

Morgan Stanley economists Richard Berner and Shital Patel commented on a decline in US business conditions in early August, with Morgan Stanley's Business Conditions Index [MSBCI] dropping 9 points to 40%. The text below is excerpted from their full analysis:

Details of the August canvass also paint a bleak picture: The advance bookings index plummeted 14 points to 46%, the lowest reading since January 2005, and our newer expectations index also fell 14 points to 39%, the first sub-50% reading in the short, 6-month history of the index. This month, hiring plans weakened further although plans to increase capital spending improved somewhat. Importantly, more analysts who had previously reported unchanged conditions downgraded their assessment of business conditions this month. The percentage of analysts noting deteriorating conditions increased to 41% from 24%. By sector, conditions continued to deteriorate for the consumer discretionary, financials, and IT groupings. Unlike last month, conditions started to deteriorate for the industrials and materials sectors. Conditions continued to improve for the consumer staples and healthcare companies. Conditions were unchanged for the energy and telecom services sectors.

Given our view that the fundamentals are supportive first of stability and then of subsequent moderate improvement, however, we can’t help but wonder if the survey’s deterioration is less deep-seated and more driven by slipping confidence among managers and the analysts who follow them. After all, respondents in August witnessed a further step up in energy quotes, sliding housing activity, talk of recession and escalating geopolitical risks. And times of uncertainty tend to shorten horizons and focus attention on the past. Thus, analysts and market participants seemed to ignore mostly better reports on global growth and some signs of bottoming in previously slipping small business and consumer sentiment and in business surveys.

Against this backdrop, we are mindful of the risks that uncertainty is the enemy of growth, and that a decline in “animal spirits” could turn what we have characterized as a temporary deceleration into a more lasting slowdown. Equally, however, market participants should be aware that while housing continues to slide, energy prices are falling, and real income and financial conditions are improving. We have also noticed that inflection points in the MSBCI occur after the earnings season. If this is the case, we should see a turnaround in the index in the next month or two.