There’s another sign the US could be headed for recession

The fears of a recession have started to fade. Economic readings haven’t been stellar lately, but it wouldn’t be hard to argue that the US economy is doing pretty good.

This sense of security, however, may be a bit misplaced says Jeremy Klein at FBN Securities. According to Klein, one indicator points him to the conclusion that a recession is coming to the US.

“While I am encouraged by the positive inertia exhibited by stocks, some dark clouds sit on the horizon,” wrote Klein in a note Monday.

“The Empire Survey has enjoyed its biggest two month sequential jump since July 2005. However, Capacity Utilization, which presents the smoothest trending growth barometer on the economic calendar, cannot reverse its downward momentum.”

The capacity utilization is a measure of the output of existing factories. Measured as a percentage, if factories are cranking on all cylinders, so to say, utilization would be at 100%. As it drops lower, that means that factories are sitting idle or not producing as much as they could be. This could then be read as a measure of demand — if people are buying less than factories will not produce as much.

Klein’s warning sign is the measure’s substantial drop over the past few years. As of Friday, the reading stands at 74.8%.

“The reading has declined 4.8% from its November 2014 peak,” wrote Klein.

Throughout the near five decade history of the series, a slip of a commensurate amount has always coincided with a recession. The second derivative of the chart has also turned more negative to counter any hope for an imminent shift upward in the data.”

If you wanted to take a more positive note on manufacturing, you could easily point to the ISM manufacturing index which has shown recent improvement. Klein, on the other hand, thinks that capacity utilization is a more “objective” measure than the survey method used by the ISM, and thus paints a more complete picture of the economy.

Capacity utilization

Now, for those that are a bit more upbeat, here is your “yeah, but…” caveat.

As noted by George Pearkes of Bespoke Investment Group, the recent decline has come from one sector: energy.

Breaking out the sub-indices, both non-durable and durable goods manufacturing have stayed relatively flat. Mining and elect irc and gas utilities utilization, however, has dropped off the table.

As seems to be the case with a good many indicators lately, it really depends on where you stand on the “ex-energy” debate.

On the one hand, it’s only outlying industry dragging the rest of the rather placid sectors down, and as oil prices stabilise there could be a recovery. On the other hand, stripping out all of the bad stuff could be blinding yourself to the full economic picture.

So it’s either a recessionary warning or just another example of how hard the energy industry has been hit. There’s something for the bulls and the bears.

Capacity subindicies

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