US Economy – Still On The Edge

Are Recent Small Improvements Meaningful?

In recent weeks evidence has emerged that the weakness in the manufacturing sector has begun to spread to the services sector as well (see e.g. Mish’s summary on the Markit Services PMI as well as the worrisome state of services activity on a global basis). This is not particularly surprising: as we have frequently pointed out, economic slowdowns and busts always tend to hit the capital goods industries first.

The sky above the manufacturing industries continues to be dark…

Photo credit: Bernat Casero

At the same time, a few data points in manufacturing have actually slightly improved – which is to say, that the pace of the declines has slowed and was in some cases not as bad as expected. This always seems to happen: as soon as economists adapt their previously overoptimistic expectations to a recent worsening trend, they will promptly be proven wrong again, as the pace of the trend slows.

Few things in this world are more certain than the fact that the consensus forecasts of mainstream economists are likely to be wrong. One can probably easily improve on their hit rate by merely flipping a coin. It is quite eerie actually – it is as if they were all Gartman clones.

However, the question that interests us is this: do these improvements mean anything? Our friend Michael Pollaro has provided us with updated charts on the situation, several of which we present below. As we have repeatedly said in previous updates, the probability of a recession has clearly increased – but the evidence that one has already begun or is about to begin shortly is not yet definitive. The following chart depicts the year-on-year change rate in the value of new factory orders, unfilled orders and inventories for non-defense capital goods excl. aircraft. Focus on the areas highlighted by the black circles and green rectangles.

Non-defense capital goods excl. aircraft: y/y percentage change in new orders (red line), unfilled orders (blue line) and inventories (gray area) – click to enlarge.

There have been two occasions when gyrations similar to the recent ones have preceded recessions – shown in the first two black circles (2000/2001 and 2007/2008). The important thing here is that the short term ups and downs just prior to the beginning of the recessions were actually meaningless. In both cases there were one or two occasions when the data improved in the short term, but it turned out in retrospect that these signals were misleading. A much sharper downturn followed shortly thereafter.

The green rectangles show “false signals” – in these two cases, capital goods orders and associated data (such as industrial production, manufacturing sales, etc.) also declined close to recessionary thresholds, but no recession ensued. Let us consider these two cases: the first occasion was in 1997-1998. This was during the Asian, resp. Russian crisis. At the time, the US economy was in the middle of a major credit expansion and in the grip of the greatest stock market mania in history.