Construction Spending
Construction spending rose an impressive 1.8% in January, and December's decline of 0.2% was revised to a gain of 0.2%. Non-residential spending finally joined the party after five monthly declines, rising 1.6%, while residential spending was up 2.0%. This puts residential spending up 9.2% over the past year and non-residential up 5.1%. All we need now is a nationwide infrastructure plan, but I'm not sure how we would pay for it. Still, this will be a positive contributor to growth in the first quarter.
PMI and ISM Manufacturing Indices
A softening in new orders to a nine-month low with overall growth at a six-month low led to a decline in IHS Markit's Manufacturing Index (PMI) in February to 50.7. That was down from 51.9 in January. Confidence levels from survey respondents surged to the highest level since April 2019, which was clearly a result of the phase-1 trade deal, but I expect that to be short-lived with the coronavirus concerns taking center stage. The virus was noted by several respondents as leading to supply chain issues. That will be a more pronounced concern in the next report, and I expect the survey to show contraction in March.
The Institute for Supply Management's Manufacturing Index slid back to the flat line of 50.1 in February from January's brief spell of growth at 50.9. Again, as trade tensions are diminishing, coronavirus concerns will take over. We can expect a significant drop in this survey for March. The Imports and Prices sub-indices plunged, while the New Orders sub-index fell back into contraction. .
PMI and ISM Services Indices
Last month I warned not to get too excited about the jump in IHS Markit's Services Index to 53.4 in January because the survey was completed pre-coronavirus. That turned out to be sage advice, as the February data showed the first contraction in the service sector in four years with the Index falling from 53.4 to 49.4. There was a significant contraction in new business from abroad due to concerns about the virus. There was also a contraction in output and employment growth slipped to its weakest since last November, which tells me there will be meaningful downward revisions to today's jobs number. This was the second steepest fall in the headline number since this expansion began, only bested by the decline during the government shutdown in 2013. I fear it will be the worst in the months to come.
The Institute for Supply Management's Non-Manufacturing Index seems to always lag Markit's measure of service sector strength in both directions. I think this is no different as the ISM Index rose to 57.3 in February from 55.5 in January. This was the highest reading since February, led by strength in new orders, employment and backlogs. Honestly, I can't explain the strength in this survey, but I'm quite certain it will be short-lived once the impact of the coronavirus is felt by respondents.
The Jobs Report
The Bureau of Labor Statistics estimates that the economy created 273,000 jobs in February, and it upwardly revised its prior two monthly estimates by another 85,000 jobs. A robust housing market that is being fueled by plunging mortgage rates is giving the labor market a much needed lift. Almost a third of the jobs created last month were linked to the housing industry. Yet there were a lot of low-paying and part-time jobs created with bars and restaurants hiring another 53,000. Temporary census workers accounted for another 8,000.
The upward revisions to December and January help to offset the loss of 422,000 jobs in the BLS's benchmark revision for 2019. It is important to remember that these monthly job estimates are lagging indicators, but they are still one of the most closely watched reports by investors. When the next recession hits the economy, these numbers won't be revised lower to reflect the contraction for months. This is what happened in early 2008 as the economy was bleeding hundreds of thousands of jobs. The BLS estimated that 2-300,000 jobs were being created each month, only to revise that gain to a loss of the same magnitude one year later. The jobs report is a backward-looking estimate that typically has a margin of error of +/- 100,000 jobs per month. That margin of error increases dramatically at turning points.
The unemployment rate fell to 3.5% from 3.6%, and the average workweek increased from 34.3 to 34.4 hours. What troubles me is that wage growth continues to slip, which comes as little surprise considering the types of jobs that are being created. Average hourly earnings rose 0.3% in February, but wage growth over the past year has slowed to 3.0%. This has wiped out nearly all of the average weekly take-home pay on an inflation-adjusted basis based on the Consumer Price Index.
The market had a muted response to what was a positive surprise in the headline number, but that is because investors know that the labor market will suffer moving forward as the coronavirus cases increase in the U.S. over coming months.
Conclusion
I have come to the conclusion that we will see at least two quarters of economic contraction in 2020. As the coronavirus spreads across the U.S., it will lead to a further decline in corporate revenues, profits and capital spending. Hiring will slow. The rate of consumer spending growth will also slow, as discretionary activity subsides until the virus is contained over the coming months. The economy was already slowing from the trade-war impact, but the change in consumer and corporate behavior as a result of the virus will be even more damaging.
An additional headwind will be the decline in financial markets, which will start to unravel the wealth effect that has served as the foundation for this top-heavy expansion. We are starting to see the first cracks in the debt market, which is where the real carnage will take place. It is at the core of the bubble in financial asset prices that has been blown by monetary policy. As revenue growth slows, if not declines, credit downgrades will wash over the corporate bond market and credit spreads will widen. This will negatively impact stock valuations for highly leveraged companies.
The Fed has fueled another cycle of boom and bust for the third time in as many decades with borrowing costs that were too low for too long in combination with too much liquidity. It's a repeat of the play we saw in 2000 and 2008 with the same cast of characters, but a totally different story line. A combination of the trade war and the coronavirus are the pins that have pricked this asset bubble. Now we just have to see whether this bubble bursts quickly or slowly deflates. Regardless, I am preparing for what I now think will be a bear market and recession in 2020.
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