Already Weak Manufacturing Impacted By Sandy
There wasn't much good news out of the New York and Philadelphia regional Fed surveys which covered the month of November. At the headline the New York "Empire" Manufacturing survey improved modestly to -5.22 from October's read of -6.16 while the Philadelphia Fed index plummeted. The impact of Hurricane Sandy is not yet fully reflected in either report and will show up in next month's report. However, while the media quickly dismissed the bad report as a temporary, and weather related, anomaly - the trend of the data has been clearly negative for months.
As stated, the New York Fed regional index remained in contractionary territory for the 4th straight month. While internal components such as new orders, inventories, deliveries and shipments all showed very small improvements - they remain mired at very weak levels.
One subcomponent that jumped out was the employment which plunged from -1.08 to -14.61. This obviously doesn't bode well for the "green shoot" of employment that surprisingly surged just prior to the election. My contention remains that we will see much of the surge revised away within the next year. The chart below shows the composite index of the Empire Manufacturing index (current and future expectations).
What is important to note is that historically, and granted there isn't a tremendous data set to work from, when the composite index has fallen below 18 the economy has previously been in a recession with the exception of 2011. The plunge in the index in 2011, which was caused by the Japanese earthquake/tsunami and the debt ceiling debate, was halted by a restart of manufacturing, plunging energy prices and the warmest winter in 65 years. It is possible that we will see a bump to the Empire index in the month ahead as manufacturing restarts - but even that will likely not be enough to reverse the current negative trend.
Likewise, the Philadelphia Fed survey, which includes the New Jersey region, showed a much more immediate impact on its constituents. The index swung 16 points from a positive 5.7 read in October to a negative 10.7 in November. However, while the "Philly Fed" headline has been negative in 6 of the last 7 months - the internal subcomponents have been negative every single month.
As opposed to the New York region, which showed mild improvement in many of its subcomponents, the Philadelphia region showed sharp deterioration in New Orders which fell 4 points to -4.6, Shipments which fell 6.5 points to -6.7, and Prices Paid which jumped from 19 to 27.9. Employment improved marginally from -10.7 last month to -6.8 but has remained negative for five months straight. Future Activity expectations also declined from 21.6 to 20 with future employment expectations declining by 50% from 8 to 4.2.
The chart above shows the negative trend of the outlook of manufacturers in the Philly Fed Region. The impact of Hurricane Sandy is not, like with the Empire Index above, fully integrated into the survey data. Therefore, it is likely that we will see the data take a turn for the worse in the next report.
While the data in both of these reports are being skewed by the impact of Hurricane Sandy - the reality is that the manufacturing data has already been signaling a weakening economy long before the storm made landfall. The chart below shows the composite economic index that is comprised of numerous economic activity reports including the CFNAI, ISM, several Fed regions including Philadelphia and New York. the NFIB small business survey and Chicago PMI.
There are a couple of important things to notice about this composite index. First, the trend of economic activity has been deteriorating since the 1980. As we discussed in "Debts and Deficits - Killing Economic Prosperity" deficit spending and surging debt levels have acted as cancer prohibiting capital formation and impeding future economic growth. Secondly, each time the composite index has fallen below 18 the economy has either been, or was about to be in, a recession. While, the economy is currently not in a recession the continuing erosion of the data is concerning.
While the hurricane is having a short term negative impact on these regional indicators the broader composite clearly shows that there is more going on than just a "one off" event. The trends of the data have been, and remain, clearly negative. Furthermore, rising component prices for manufacturers, as we have warned many times in the past (as early as May 2011), are now being reflected in the erosion of corporate profit margins. This is not a one quarter issue and earnings weakness is very likely to persist in the coming quarters ahead.
The market is already selling off in anticipation of a "fiscal cliff" issue as witnessed by money rotating out of risk assets AS WELL AS the defensive sectors such as staples, utilities and MLP's. This is due to investors trying to jump ahead of the anticipated tax increases coming at the end of the year in both capital gains and dividends. However, the weak economic environment, recession in Europe and deteriorating earnings also leave investors exposed to a much more serious decline in the months ahead as markets begin to reprice assets that have become detached from fundamentals. Holding extra cash, and fixed income, at the current time is a great way to offset portfolio risk until a clearer picture emerges. Market declines are always welcome buying opportunities - as long as you have cash to take advantage of it.