About a week ago, I spent an afternoon playing basketball and drinking beer with a best friend from my high school days. It was the second get-together in five months. How is that unusual? Prior to the first go-around this past May, I had not seen Anthony in more than 30 years.
I asked Anthony if he remembered the night that we knocked over the practice field’s goal posts. (Give me a bit of “labor slack” here… we were teenagers in a small town.) Not only did he recollect the incident, but he was able to conjure up the Billy Idol song that he had imitated shortly after the structure had tumbled. “Well there’s nothing to lose and there’s nothing to prove and I’ll be dancing with myself, oh oh oh oh.”
Not every memory that came up shared the same FL-diamond clarity. He asked whether or not I kept the New York Giants “hacky sack” that he gave me on my birthday. I could not recall ever having received the gift. For that matter, I did not think that either one of us had ever shared an interest in kicking a small bean bag up in the air. Similarly, when I inquired about the time that we had taken his brother’s Datsun 280z without permission to go on a double date, Anthony seemed to believe that I was thinking about someone else entirely. “Phil did own a 280z, right?” Yes. “You don’t remember taking it to go out with Michelle and Erin?” No.
Perhaps ironically, folks seem to hold completely different memories regarding the circumstances leading up to and surrounding the last recession (12/07-6/09). Some have written to me directly to say that there were “many economists and analysts” who anticipated the downturn, providing investors ample opportunity to escape the stock market decimation unscathed. That’s not accurate. I introduced a recession forecasting tool to popular financial web portals in December of 2007 that placed the odds of a recession in the ensuing 12 months at 70%; the same model appeared in Investor’s Business Daily in January of 2008, bumping up the likelihood to 80%.
In contrast, the overwhelming majority of mainstream economists and analysts were forecasting 2.5% GDP growth or better for 2008. Very few analysts and economists shared my belief that a recession was a strong probability. Even after the S&P 500 flirted with 20% losses in March of 2008 – even after dropping 20% by July of 2008 – GDP growth was telling the overwhelming majority of economists that recession fears were overblown.
| Third/Final Report 2008 U.S. Economy | ||
| Q1 | 1.0% | |
| Q2 | 2.8% | |
| Q3 | -0.5% | |
| Q4 | -6.3% | |
How will you know when the U.S. economy is in trouble? You might want to consider what the Federal Reserve’s inaction and statement (9/17) actually means. In particular, the global economy that we participate in has been weakening, our manufacturing segment has been downright abysmal and extraordinary weakness in labor force participation matters.The overwhelming majority of economists and analysts did not become “skittish” until late in the summer of 2008. It is the reason that the academics in the National Bureau of Economic Research (NBER) did not declare that a recession had started in December of 2007 until October of 2008. They needed to ignore the textbook definition of GDP of two consecutive quarters of contraction in making that call, as GDP had not contracted until Q3 of 2008. In other words, you will not be able to count on a textbook definition of GDP to understand when the U.S. economy is in trouble.
Do I think that the U.S. economy is hopelessly lost. No, I do not. However, levered asset price reflation (e.g., stocks, real estate, etc.) is the primary driver. Absent that, things are a whole lot bleaker than Wall Street would like you to believe.
Here, then, are 13 economic charts that might help you identify risks in the economy as well as risk of loss in your investment portfolio:
1. Anemic Wage Growth. The Employment Cost Index served up its worst reading since the measure first came out in 1982. Try explaining to a middle class American that the economy is standing on solid ground when his/her wages are stagnating. Should he/she believe that gas prices will stay lower for much longer? Should he/she feel confident that interest rates will stay lower for much longer? Wage and salary growth are a necessary component for “confident” consumption, as opposed to relying too heavily on credit cards.
2. Consumer Sentiment. Consumer sentiment declined to the lowest level in a year, falling from a reading of 91.9 in August to 85.7 in September. It gets worse the more you dig into the University of Michigan’s sub-indexes. “Current Conditions” fell at a 4.6% rate, while “Future Expectations” fell at an 8.4% clip. What does that mean? Consumers expect the economic and employment conditions, as well as their personal finances, to worsen in six months. When people anticipate more difficult times, they tend not to spend as much.
3. Dismal Labor Force Participation. I find it fascinating how often “group-thinkers” tout the headline unemployment rate of 5.1% when 94 million working-aged people are neither employed nor making plans to find work. The employment rate for working-aged individuals is only 62.6% – a rate that is stuck in the late 70s. Want another way to look at how bad this is? 94 million potential workers are no longer making contributions to the growth of the U.S. economy.
4. Inactivity Rate for Prime-Time Earners. Think the dismal labor force participation is due solely to the retirement of baby boomers? The next chart should debunk that antiquated notion. If the 55+ crowd, or 65+ crowd, were retiring en masse, you could strip them out of the picture. Indeed, you should then expect the inactivity rate for prime-time earners in the 25-54 demographic to go down, since the portion of this sub-set of the working-aged population should be working again once you strip out the retirees. Unfortunately, that’s not the case. The inactivity rate for these workers is still rising dramatically.
5. Consumer Spending. According to the most recent Gallup poll, American’s daily spending dropped to $89 in August. That’s down from both August of 2014 and August of 2013. Equally troubling, consumer spending has dropped on a year-over-year basis for 4 consecutive months; it has dropped six of the last eight. So when will the massive stimulus from half-priced energy kick in?
6. Poverty and Extreme Poverty. In many ways, when it comes to economic progress, we tend to focus more on the so-called “middle class” and the so-called “1%.” We tend to ignore the adverse impact of more and more people becoming dependent on redistribution by the federal government. The people living in extreme poverty recently rose to an all time high of 20.8 million. A record 46.7 million Americans are living in poverty. And there is little evidence that food stamp enrollment would decline in a meaningful way.
7. Retail Sales Growth Stalls. Economic cheerleaders have short memories. The wealth effect of rising stock portfolios and rising home prices – circumstances created primarily by three decades of lower borrowing costs – can quickly reverse itself. Economic well-being in a consumer-oriented society is about high quality, high paying jobs with increasing prospects for advancement; economic well-being in a consumer-oriented society depends on the confidence to spend one’s wages/salaries based on non-transitory factors. (Remember, the Fed calls “low energy” a transitory factor.) It follows that we may be seeing the beginning of retail sales trending negative in a year-over-year basis. And that cannot be a healthy sign.
8. Revenue Contraction For Businesses. Do we already have a revenue/sales recession at major corporations? For instance, this will be the 3rd consecutive quarter of sales declines for the 30 companies in the Dow. Thank god for Apple. In fact, without Apple, the “info tech” sector would be reporting sales declines in the 3rd quarter. Note the rollover at the onset of previous recessions for total business sales.
9. CEO Economic Outlook Waning. I think it’s safe to say that CEOs at major corporations are in positions of considerable power. For instance, if their confidence in the U.S. economy declines significantly, they might be less willing to hire. The Business Roundtable reported that its CEO Economic Outlook Index has dropped all the way to 74.1 in Q3. That’s the lowest since three years ago in 2012. These are the same folks who will be faced with the choice of trying to boost share prices through stock buyback programs or going on a hiring spree or investing in plants/equipment or R&D. Looking at the sales, and the Federal Reserve, these folks may be getting ready to hunker down, not ramp up.
10. Manufacturing Freefall? Supposedly, 70% of the U.S. economy is tied to consumer activity. Nevertheless, this does not render the businesses that make stuff obsolete. And the only time that manufacturer new orders across all industry looked this horrendous? Before the last two recessions.
11. Inventory-to-Sales Ratio. At 1.36, this is the worst that this measure of business health has been since the last recession. Inventories have been piling up and sales have been going nowhere. In fact, if I am not mistaken, the wholesale inventories to sales has never been this high in its history. In essence, companies may be facing larger financial problems when they are collectively struggling to keep inventory down while sales are simultaneously slowing. It is a huge negative for the U.S. economy.
12. Global Economic Slowdown. There’s no other way to put this gently: The world economy is on the brink. Brazil, Canada, China, half of Europe, Australia, half of Asia, half of Latin America – countries have either entered recessions or they are trending in that direction. If nothing else, we should be cognizant of the reality that the U.S. is a part of a global economy that is decelerating. JP Morgan’s Global Manufacturing PMI is now at 50.7 where a reading below 50 would be indicative of a global manufacturing recession.
13. Credit Concerns Resurface? 3-month U.S. Treasury bills are deemed risk-free. In contrast, the rate associated with Eurodollar futures tends to reflect creditor ratings of corporations that borrow. When the spread between the two (a.k.a. TED Spread) rises, fears of default also rise. With the TED Spread at a 3-year peak, what might this be saying about the health of the global financial system?
In truth, I could easily provide 13 more unsavory charts of significant issues pertaining to the well-being of the U.S. economy. I stopped here to emphasize that these are the types of issues that the Federal Reserve recently grappled with when they decided not to leave zero percent rate policy behind them. Implicitly and explicitly, they’ve talked about needing to see labor force participation improvement as well as wage growth improvement. They haven’t gotten it. Implicitly and explicitly, they’ve talked about a desire to meet a 2% inflation target that they deem healthy for the U.S. economy. They have 0.3% year-on-year for July. And in the most recent meeting, as if market watchers were caught off guard, the Fed acknowledged that the U.S. is not an island unto itself; we are part of a global economy that has been crumbling all around us.
In last Friday’s commentary, I primarily focused on technical, historical and economic reasons “Why The S&P 500 Is Likely To Revisit The Correction Lows Near 1,870.” For those who want to review fundamental valuation and market internals – you might wish to return to “15 Warning Signs of a Market Top.” The feature was written prior to the August-September correction.
Keep in mind, it may be a challenge for some of the economic woes to subside. Absent a Fed that commits to moving at a pace like a 3-toed sloth – or one that actually reverses course to provide more QE-like stimulus – economic growth concerns will continue to weigh on investor sentiment in the near future.
If you had been 100% in cash prior to the selling pressure, you might look to purchase the S&P 500 SPDR Trust (SPY) in three increments. Your first increment might be near the correction lows of 187.5. If the lows of the market hold, you could purchase a second increment 5% higher near 197. I would not a commit a third and final increment without a break above the 200-day moving average.
Gary Gordon is president of Pacific Park Financial, Inc.