Morgan Stanley's Business Conditions Index, which is designed to capture turning points in the U.S. economy, fell from a level of 45 in May to a level of 13 in June - a whopping 32-point decline.
This drop is the largest one-month decline in the history of this indicator. The June reading also represents the lowest reading for the indicator since December 2008 during the depths of the financial crisis.
The underlying details of this index point to widespread expectations of very broad-based weakness in virtually all segments of the economy.
In particular, the severe weakness in the manufacturing sector that is reflected in this report is very much in accordance with my latest article, and a special report to my subscribers titled "The Cost of A U.S.-China Trade War Shock."
My own view is that the U.S. economy is not in as bad a shape as Morgan Stanley's Business Conditions Index would suggest. I believe that this diffusion-type indicator is accurately reflecting the certainty of a slowdown and that it is also accurately capturing the breadth of the slowdown. I believe that it is also accurately reflecting a very significant shift in economic momentum - at least in the short term. However, it is my view that the construction of this particular diffusion indicator can lead to misinterpretations that will tend to exaggerate the apparent degree of weakness in the U.S. economy.
However, this particular indicator is signaling something very important which confirms what I have been pointing out to my subscribers in the last week:
1. The U.S.-China trade/economic conflict is having extremely disruptive effects on the U.S. economy - particularly in the manufacturing sector. As a result, I expect to see a very significant deterioration in economic data reported during the remainder of May through late June, at least.
2. The ISM manufacturing report released in early June is very likely going to indicate that the U.S. manufacturing sector is currently in recession.
3. Given the severe loss of momentum in the U.S. economy - which will become increasingly apparent in the next month - a significant worsening of the trade conflict with China has a very high probability of triggering a U.S. economic recession. The recession would be led by severe weakness in the U.S. manufacturing sector.
The U.S. economy is currently in a severe free-fall process of collapse if you believe Morgan Stanley's Business Conditions Index. I don't believe it.
However, this indicator suggests that there has been a very significant shift in economic momentum and that expectations for future business conditions in virtually all areas of the U.S. economy have turned extremely negative.
It is my view that, given the severe loss of momentum in the U.S. economy, a significant escalation of the trade/economic conflict with China could trigger a U.S. economic recession. It is currently not my base case expectation that an escalation of the U.S.-China conflict will occur or that the U.S. will soon fall into recession. However, I have designed a portfolio strategy which accounts for this risk in the Total Return Model Portfolio that I feature in Successful Portfolio Strategy.
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