Durable Goods - Highly Volatile But Trend Tells The Story
There was much excitement this morning on the back of the latest durable goods orders report which showed a rebound of 1.1 percent in May after a downwardly revised -0.2 percent decline in April. The immediate conclusion by the mainstream media was that even though the manufacturing sector has shown weakness as of late - today's durables report shows some bounce in the sector.
Do not jump to that conclusion too quickly.
First, the durable goods monthly report is highly volatile as shown by the accompanying chart. It is impossible to discern any trend from the month to month data as released in the report. As we have stated repeatedly in the past - the data points are not important. What is critical to understand is the trend of the data over time.
Durable goods have been on the decline since they reached their last peak in early 2010 as the massive inventory rebuilding surge, driven by QE 1, was in full swing. The second boost in durable goods, albeit substantially smaller, came on the back of QE 2 but failed to achieve a new peak. This is a clear example of the "diminishing returns" of stimulative programs that Bernanke addressed in his testimony to Congress recently.
However, what is clear is that the trend is clearly negative and weakening substantially during the first half of 2012. With the Eurozone already in recession the drag on exports is increasing. While the U.S. and Eurozone economies have decoupled - the recent slate of economic reports is now calling the sustainability of that decoupling into question. With the U.S. more dependent today on exports than in the past the ongoing, and deepening, recession in Europe will continue to exert a greater drag on the U.S. economy. The two major economies have decoupled in the past, however, that decoupling has been temporary as the symbiotic relationship between the U.S. and the Eurozone reverted back to normalcy.
Nothing shows the current state of the U.S. economy quite as good as the STA Economic Output Composite Index (EOCI). The EOCI is a weighted composite index of the CFNAI, ISM Composite Index, several major Fed manufacturing regions and the NFIB Small Business Index. The purpose of the index is to provide a much broader and clearer picture of the overall state of the U.S. manufacturing and business economy versus looking at each individual report. By comparing the year-over-year change in durable goods orders to the EOCI we find, not surprisingly, a very close relationship. The current weakening trend in the EOCI suggests continued weakness in the durable goods report next month as the EOCI declined sharply in May from 32.99 to 31.62. Early June reports from the Philly Fed and Richmond districts, components of the EOCI, came in much weaker than expected which suggests a weaker EOCI report by the end of June.
Overall the weakness in the economy is becoming much more pervasive from manufacturing to employment. The recent upticks in housing reports will be very transitory as they are due to a combination of seasonal adjustments and the seasonally strong period. Without further stimulative support from the Fed in the form of a balance sheet expansion program (QE3), which we expect to occur between August and September, the economy will slip into a recession by the end of 2012 or early 2013. As we continue to reiterate it is very important to remain conservatively invested at the current time until the current negative trends begin to reverse and improve.