Turning Points For The Week Of December 31-January 4
Hale Stewart | Jan 06, 2019 12:54AM ET
Summary
The corporate profit outlook is weakening.
Credit market leading indicators are still pointing towards a slowdown.
The employment report was a much needed shot in the arm.
The purpose of the Turning Points Newsletter is to look at the long-leading, leading, and coincidental indicators to determine if the economic trajectory has changed from expansion to contraction - to determine if the economy has reached a "turning point."
h2 Leading Indicators/h2Corporate profits are a long-leading indicator. According to the latest Zacks' report , things aren't looking good (emphasis added):
Market anxiety about the economic outlook has put a question mark over consensus earnings expectations. Estimates have been coming down lately, reflecting the impact of economic weakness and rising costs.
Apple (NASDAQ:AAPL)'s announcement this week (which I discussed on Thursday ) is most likely the tip of the iceberg. Also, remember this is the last quarter of positive Y/Y comparisons. The drop in corporate tax rates provided a strong boost to last year's first-quarter numbers and will make this year's results less impressive on a Y/Y basis.
Although I don't regularly quote this number in Turning Points, the ISM's manufacturing index contained concerning anecdotal comments:
- "Growth appears to have stopped. Resources still focused on re-sourcing for U.S. tariff mitigation out of China." (Computer & Electronic Products)
- "Brexit has become a problem due to labeling changes." (Chemical Products)
- "Customer demand continues to decrease [due to] concerns about the economy and tariffs." (Transportation Equipment)
- "Starting to see more and more inflationary increases for raw materials. Also, suppliers [are] forcing price increases due to tariffs." (Food, Beverage & Tobacco Products)
- "The ongoing open issues with tariffs between U.S. and China are causing longer-term concerns about costs and sourcing strategies for our manufacturing operations. We were anticipating more clarity [regarding] tariffs at the end of 2018." (Machinery)
- "Business is steady, but pace of incoming orders are slowing." (Furniture & Related Products)
- "Business is robust for certain sectors [aerospace] and flat to downward for others [energy]. Tariffs continue to impact business direction and profit." (Miscellaneous Manufacturing)
- "Caution seems to be the outlook. Are we in a correction, or is the market getting ready to slow over time?" (Fabricated Metal Products)
- "No major change in business operations towards the end of 2018; however, we are carefully monitoring oil prices and outside influence from market conditions to better understand our 2019 outlook and capital plans." (Petroleum & Coal Products)
- "Customers are hedge buying in December as a result of announced price increases starting in January." (Textile Mills)
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I'm spotlighting these comments for two reasons. First, over the last year, the headline PMI had printed in the upper 50s and lower 60s, which are very strong levels. This report contained not only a sharp drop in the composite reading (falling 5.2 points to 54.1) but also an 11 point drop in the new orders index, which is now a barely positive 51.1. That's a marked difference that could indicate a fundamental shift in manufacturing sentiment. Second, sentiment leads data. Bearish commentary eventually translates into slower economic activity. Assuming these comments are representative of most sentiment, then we can expect less activity during 1H19.
Let's turn to the credit markets, whose performance is a key reason why I currently have a 30% recession probability. The long-end of the curve continues to trade in an end-of-cycle pattern.
The 10- and 30-year Treasury bonds have both fallen around 40 basis points. Traders are now seeing lower future growth, which means lower inflation, which makes longer-term debt more attractive. This usually happens at the very end of an expansion.
Until recently, the rise in short-term interest rates was the main reason for the flattening yield curve. The fall in long-term interest rates is now aiding that process:
The 10-year-3-month spread continues to fall and is now below 25 basis points.
The fall in long-term rates along with the continued tightening of the curve is a bearish development.
Finally, let's look at employment leading indicators:
The average weekly hours of production workers (left) are still strong while the four-week moving average of initial unemployment claims (right) has decreased a bit over the last few weeks. Both of these numbers are strong.
Leading indicator conclusion: Corporate profits are looking a bit weaker. The credit markets are still flashing yellow. Lower-rate credits are tightening and the yield curve continues to flatten. The ISM report could potentially show a bearish change in manufacturing sentiment. We'll keep an eye on durable orders for consumer and capital goods over the next few months to see if that plays out. The combined reading of this data keeps my recession probability over the next 12-18 months at 30%.
h2 Coincidental Indicators/h2Friday's employment report was obviously very welcome news for the market, with a 312,000/month headline number. Key report internals were also positive (emphasis added):
In December, average hourly earnings for all employees on private nonfarm payrolls rose 11 cents to $27.48. Over the year, average hourly earnings have increased by 84 cents, or 3.2 percent. Average hourly earnings of private-sector production and nonsupervisory employees increased by 9 cents to $23.05 in December. (See tables B-3 and B-8.)
The change in total nonfarm payroll employment for November was revised up from +155,000 to +176,000, and the change for October was revised up from +237,000 to +274,000. With these revisions, employment gains in October and November combined were 58,000 more than previously reported.
Earnings are increasing and establishment job gain revisions are on the plus side; both are very positive developments. In addition, the moving averages of establishment job growth remain around 200,000:
(Data from the FRED system; author's calculations)
In fact, the 3-, 6-, and 12-month moving averages are 254,000, 222,000, and 220,000, respectively. These are remarkable numbers for an expansion in its eighth year.
Coincidental numbers conclusion: The employment report was about as good as you can ask for. These indicators continue to show an economy in good shape.
Conclusion: The weight of the bearishness in the leading indicators keeps my recession probability at 30%.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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