Trade Deficit - Recession Warning Ticks Up
Last month we saw a small uptick in exports that got economists all excited that the domestic economy was avoiding the drag from the Euro area recession. We wrote then:
"If the data is truly improving we will need to see a string of consecutive positive months ahead. This is highly unlikely. The negative trends of the import and export data is pointing to a weaker economy, and a recession, in the months ahead. The current decline in earnings and revenue, the drop in exports and the weakness in incomes will likely impact stock prices long before the mainstream media recognizes that a recession has set in. As stated above there are many confirming indications that a recession is already underway in the U.S. economy - the only question is how long it will be before the stock market recognizes it and begins to realign prices with revised valuations."
As expected the trade defict widened in October on higher oil imports, slippage in the services surplus and continued weakness in Europe and Japan which crushed exports. While the trade deficit worsened to $42.2 billion from $40.3 billion in September (originally $41.5 billion) - exports plunged by 3.6 percent in October, following a 3.1 percent rebound the month before. Furthermore, the slowing domestic economy impacted the need for imports which fell 2.1 percent after gaining 1.5 percent in September.
The trend of trade has been clearly negative as the recession in Europe, and slowdown in China, have reduced end demand. This has been very much reflected in the third quarter corporate earnings' announcements and forecasts through the end of the year.
The chart below shows the trend of deterioration in imports and exports and its net effect on the economy. As always, it is the trend of the data that is far more important than any single data point when trying to develop a macro outlook.
Importantly, the decline in imports in October registered a negative year-over-year reading of -0.8%. Since 2000 the only other negative readings have occurred only during recessions. Exports are currently at a 1.0% annualized growth rate but given the negative trend of the export data it is likely that we will witness a negative annualized growth rate of exports within the next two months.
As we stated last month with regard the boost in exports:
"[Trade data] also may be an ephemeral artifact due to disruptions in the flow of trade-data reporting related the impact of Hurricane Sandy. Due to the late October arrival of the storm some of the reports on imports have likely been delayed leading to a shortfall in the trade estimates. Such distortions should be corrected in next month's reporting which will send economists scrambling to reduce the GDP estimates once again."
That indeed has been the case and economists are now scrambling to reduce GDP estimates to 1%, or below, for the Q4 reporting period. Regardless of such distortions in the short term, as we saw last month, the longer term trend of the trade data is clearly one of deterioration. Therefore, while analysts are currently predicting a resurgence of corporate earnings in 2013, with some estimates as high as $108/sh, the reality is that unless the trade data substantially improves in the coming year both economic activity and corporate earnings will remain under pressure.
The reason I make this statement is that exports are currently comprising roughly 40% of corporate profits and, as discussed previously, 13% of GDP (as opposed to housing and automobile manufacturing which comprise about 2.5% each.) The drag from slower rates of exports will slow economic growth.
As the chart below shows - historically when exports, as a percentage of GDP, have turned down the economy has weakened. The downturn in 1998, due to the "Asian Contagion," was offset by economic growth that was strong enough, due to the technology bubble, to avoid a recession. However, each successive downturn has coincided with economic weakness. As exports have climbed to represent a larger share of corporate profits and the economy the impact to the economy has become more significant.
The retrenchment of exports in the latest trade data report is not likely to be the last as the recession in Europe grinds on. With Japan now officially in a recession, China growing at a slower pace, and domestic activity slowing down further declines in the volume of exports is likely.
While exports are not a primary recessionary indicator the weakness in the export data should not be dismissed in assessing the overall strength and direction of the domestic economy. The next couple of months, as retail sales, production and income data are tabulated, will tell us much about the real state of the economy and the most likely timing of the next recession.