Global PMI Data May 2013

With all of May’s Global PMI data now reported, below are charts of how the numbers look for both manufacturing and services indexes from around the world.

Both global composites are still above 50 and therefore in expansion territory, but the manufacturing surveys imply that the manufacturing sector is slightly more gloomy than the services sector.  Perhaps something that is particularly worrisome on the manufacturing side is that three important economies that were above 50 in February have now fallen into contraction territory: Germany, China and the US.  On the bright side Japan and the UK appear to be on the upswing in both surveys, and Spain, Italy and France are contracting at a slower pace than they were to start the year.

May Global PMI

May Global PMI Services


Data via Markit Economics

Does Negative GDP Growth Portend Recession?

While it was generally expected that 4Q was a slow quarter for economic growth, it was probably a surprise to many that the growth rate was negative.  What are the odds that this negative growth portends a recession?

Assuming that the revised number remains negative this is the 42nd time in 279 quarters since 1947 that quarterly GDP growth has been negative.  Of those 42 times, 27 of them came during a recession (as defined by NBER).  Therefore GDP has contracted 15 times while the economy was not in recession.  Below is a list of those times.  The economy entered into a recession in the following quarter five out of those fifteen times.

Of course, NBER defines recession dates after the fact, so we could be in a recession right now and just not know it.  Given that the market is hardly lower today, that would probably be a surprising result.

Note: Figures are NON-Annualized

Nominal GDP Grew at 5.5% in 3Q12

The first revision of 3Q12 GDP was released this morning and showed that GDP grew at 2.7% annualized during the quarter, which was 0.7% better than the initial estimate.  That’s also 1.4% more than it grew in 2Q12, when it only grew by 1.3% annualized.

People often forget that the headline GDP number is reported on a “real” basis, which means that it is adjusted for inflation.  In reality, real GDP is anything but real though, since the world is measured in nominal, not real numbers (especially important for debt), and economists do a debatable job of measuring inflation anyways.

On a nominal basis GDP was up 5.5% annualized last quarter, a pretty big number!  The deflator (inflation) ran at 2.7% which is also a fairly large number in its own right.  The 5.5% growth was actually the largest quarterly increase in nominal GDP this cycle, although it’s not quite as large as it was at other points last decade.

Nominal GDP Growth
Source: BEA

Katrina’s Effect on Jobless Claims vs. Sandy

Before Sandy hit I mentioned that jobless claims would be one of the more sensitive economic indicators to any disruption caused by the storm.  Checking back in, today we found out that jobless claims spiked 78,000 following the storm to 439,000.  In 2005, claims rose by 96,000 after Katrina hit and it took six weeks for claims to fall back to their previous level.

Seasonality of Business Inventories

Business inventories were reported today up 0.7% for September which is slightly higher than expected.  Inventories are an important economic data point to watch because GDP growth is highly sensitive to expansion and contraction in inventories.  Currently, the inventory to sales ratio is at 1.28x which is slightly higher than it was to start the year.  This is something to keep an eye on because if inventories rise faster than sales, there can be an inventory liquidation and a corresponding contraction in GDP.

Cyclically speaking, inventory data is important to GDP but is somewhat difficult to interpret because it is also affected by secular and seasonal variance.  On a secular basis, businesses have found a way to continually become more efficient and reduce inventory over time.  This makes it difficult to interpret what the “right” level of inventory/sales should be.

Seasonally, inventories will also shift in response to the holiday shopping season.  The government data is supposed to be adjusted for this, but is imperfect.  On average since 1992, inventories are ~6% higher in November than they are to start the year.  This year, inventories have grown a little more than average since January.  (Note that it’s important not to read too much into whether that means that companies are “over-inventoried” because the chart is really just showing the seasonality in any single year.)

Are we Heading For a Recession?

Every time the equity markets go through a correction the recession chatter seems to pick up.  In the last few days, the chart below has started to pop up around the internet in support of the idea that we might be heading for one again.  It’s a recession probability index (which isn’t widely followed to my knowledge) but has a good track record of predicting previous recessions and is past the threshold that has signaled false alarms before.

The indicator was developed by two professors, Marcelle Chauvet and Jeremy Piger.  The inputs are: “a dynamic-factor markov-switching model applied to four monthly coincident variables: non-farm payroll employment, the index of industrial production, real personal income excluding transfer payments, and real manufacturing and trade sales.”

I’m not particularly familiar with this indicator so it’s tough to know what the biases could be, but I generally tend to be somewhat skeptical of models like this one.

A more time tested recession indicator is the slope of the yield curve–when the spread between 2 year and 10 year treasuries is inverted recession normally follows.  In a zero interest rate environment the yield curve may have lost some of its informational content, but it’s been a great cyclical indicator for a long time and it’s grounded in sound economic logic, so it shouldn’t be totally ignored.  Today, even though the curve has flattened since ’09 it is still not at or near the zero threshold.  As of right now I’m still on the lookout for the yield curve to go completely flat or invert when recession is imminent, even in this environment.

To clarify, I did write yesterday in my investor letter that I think recession will happen sometime in the next presidential term, but that doesn’t necessarily mean it’s imminent.  My base case is that it could start sometime late next year absent a totally botched fiscal cliff.  The forecast is mostly reliant on the average duration of economic expansions.  As I’ve written before, this expansion would be short even compared to the 1933 expansion if it ended today.

How Many Hours of Work Does it Take to Buy…

The reason that economists adjust nominal data to “real” numbers is that they are trying to create a better picture of general welfare after adjusting for inflation.  If an economy produces $100 worth of widgets one year and $150 worth of widgets the next, the dollar increase doesn’t tell you much if the price of a widget also rose from $100 to $150.  In that case the economy has still produced one widget in the year, so welfare has not changed and theoretically real GDP should be flat.

At a fundamental level, “real” economic numbers are an attempt to measure output against time.  In the previous example, the data was adjusted to have a more clear picture of the number of widgets produced per year.  For humanity, time is really the only scarce resource there is.  Therefore, the number of hours worked that it takes a person to buy an item is the true measure of welfare.

Today’s employment report showed that average hourly earnings fell slightly to $23.58.  Below are charts of the number of hours that it has taken to purchase a home, a barrel of oil, an ounce of gold and “an S&P 500,” at the prevailing hourly wage of the era.  In general a downward slope would mean that societal welfare is increasing because it would take fewer hours to buy the same good.

Long Term Durable Goods Orders Chart

Durable goods orders posted a terrible print this morning for August.  The Series showed a 13% m/m decline.  Much of this came from the transports component, which is notoriously volatile.  Still, the magnitude of the drop is certainly noteworthy.

The 13% decline is the 3rd largest drop in the history of the series which goes back to 1992.  There hasn’t ever been this large of a decline outside of a recession.

Before we declare the end of this expansion though, it is most likely that this is an anomaly rather than an indication of the state of the economy.  To some extent this datapoint was already reflected in the sub-50 ISM reading that was reported at the beginning of September.  For a more salient indicator, all eyes should be on how ISM measures this coming monday.

Durable Goods Orders Long Term

Housing vs. Equities

Case Shiller was reported this morning up 1.2% y/y for July.  The datapoint serves as confirmation that housing prices are recovering.

Below is a chart of Case Shiller vs. the S&P 500 since 2000.  It shows that even though housing prices may be starting to turn, they still have quite a ways to climb.  Also it highlights that even despite the housing bubble burst, housing prices have still risen since the turn of the century and have thus outperformed equities.

Housing Outperforms Equities

ISM as Recession Indicator

ISM was reported at sub 50 for the 3rd month in a row.  Does that mean that a recession is imminent?

Below is a chart of ISM stripped down to only include times that the indicator has been below 50 for at least 3 months in a row.  There have been roughly 17 periods in which ISM has had a 3 month sub-50 streak.  Of those 17 times, 6 have been outside of a recession: 1951, 1967, 1985, 1995, 1998 and 2003.