The recent return of high volatility to the stock market, bond market and currencies suggest the end of the rally that started in November and probably to the upsurge since the March 2009 bottom. As we stated in last week’s comment the market now appears to be entering a lose-lose situation where economic growth is bad since it forces the Fed to “taper’ its bond buying program, a move that investors, as they have most emphatically demonstrated this week, do not like one bit. On the other hand, if the economy continues its tepid pace (or worse), as we think it will, employment won’t meet the Fed’s goals and earnings will take a dive. In the latter case, the Fed would likely delay tapering of its bond-buying program and investors will interpret bad news on the economy for what it is—-bad news.
In comments over the last two months we have shown how various important sectors of the economy have either been slowing down or failing to meet expectations, a condition that has indicated no signs of reversing. The four-week moving average of new weekly unemployment claims has moved from 338,000 to 353,000 over the past month. The ADP employment report for May came in far under expectations, and has averaged 124,000 over the last two months compared to 203,000 over the prior five. The majority of Fed regional surveys have showed weaker hiring in May than in April. The National Federation of Independent Businesses (NFIB) recently reported reduced hiring in May.
The ISM manufacturing index of 49 for May was the lowest since June 2009, when the recovery was only getting underway. That number was even worse than it looked since new orders plunged 3.5 points while inventories rose. The ISM non-manufacturing index for May was down from a year earlier, and has not recorded a monthly increase since December. Moreover, its employment index component dropped from 52 to 50.1, its fourth consecutive decline. Consumer expenditures for April declined 0.2% and disposable income 0.1%. Compared to a year-earlier, real consumer spending is up a paltry 2.1% and real disposable income only 1%. Even then, consumers were able to maintain this inadequate rate of spending only by reducing their savings rate to 2.5%. Notably, the savings rate was under 3% in each of the first four months of the year, whereas prior to this year the rate had not been under 3% for any month since December 2007, the peak of the economic cycle.
Real GDP has increased only 1.8% over the last four reported quarters, within a range that has been in force since the first quarter of 2010. The current quarter is shaping up as no better. Manufacturing production has declined for the last two months and three of the last four. Even vehicle sales, which recovered strongly from the recession bottom, have now flattened out for the last six months. The Chicago Fed national activity index, which covers a broad swath of the economy, showed deterioration in growth in April, and has been negative in three of last four months.
Although there is a lot of talk about a stronger economic recovery, the facts, as outlined above, indicate otherwise. Furthermore, the effects of the sequester, which started very slowly, are starting to become more evident in slowing wage growth and reduced hours. The original estimates of a 1.5% drag in GDP growth from the tax increase and sequester still appear to be valid and will likely be felt in the 2nd and 3rd quarters. We therefore think that the overly optimistic earnings forecasts for the rest of year will be highly disappointing. Although 1st quarter earnings slightly beat the consensus, revenues were flat, and corporations will find it exceedingly difficult to increase earnings with no help from revenues, which are likely to remain under pressure.
In addition, global growth is slowing with much of Europe in recession, China coming in short of expectations and emerging markets weakening. We have continually pointed out that following a huge buildup of consumer debt it would be difficult to generate a normal recovery in either the U.S. or the rest of the world, and there is little that governments can do other than to choose between undergoing a major crisis or to endure prolonged sluggish growth. Four years after the recession bottom, we see no reason to change this view.
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