STA Economic & Employment Composites Paint Weak Picture
With the recent release of the Chicago Fed National Activity Index (CFNAI) I can now complete my economic and employment composites for March. The problem, as I see it, with most economic data is that it is generally too specific to a particular region, or industry, to tell us much about the health of overall economy. Furthermore, the data is generally viewed on a month over month basis which obfuscates the real story behind the data which is revealed by analyzing the overall trend.
For example, let's look at the CFNAI report for March as it analyzed by Econoday:
"March, in contrast to February, was not a good month for the nation's economic indicators. The Chicago Fed's national activity index fell to minus 0.23 vs February's upwardly revised plus 0.76.
A negative reading indicates that national economic activity is below its historical trend. March's weakness pulled the three-month average from February's plus 0.12 to minus 0.01.
The biggest change in March is in production indicators which still contributed to growth, at plus 0.01, but well down from February's plus 0.47.
Helping to pull the index into negative ground during March was employment, at minus 0.06 vs February's plus 0.31. Sales/orders/inventories fell to minus 0.02 from plus 0.13.
Consumption & housing pulled down the index down the most, at minus 0.14 for a second straight month."
From that analysis we know that March was weaker than February but what does that tell us about the economy as a whole? Is March an anomaly? Or was it February since it was revised up? Is the economy as a whole shrinking or growing? The problem with analyzing a single data point in time is that it takes it out of context. Let's look at the chart below which is the 12-month average of the CFNAI overlaid against the S&P 500 Index.
Two things become clear when viewing the data this way.
First, as we discussed last week, economic activity peaked in early 2011 and has been contracting since. When analyzing the data this way it becomes apparent that the bump in activity in February was an anomaly within a trend of weaker data points.
Secondly, peaks in activity have correlated with peaks in the financial markets as economic deterioration negatively impacts earnings and ultimately leads to reversions in market valuations.
With this understanding we can now discuss the two composite indicators I have created specifically for developing a broader picture of the data trends in the economy and employment.
STA Economic Output Composite Index (EOCI):
The EOCI is a composite index consisting of the CFNAI, the Chicago PMI, the ISM Composite Index (an average of the Manufacturing and Non-Manufacturing Surveys), several Federal Reserve manufacturing surveys, the NFIB Small Business Survey and the Leading Economic Indicators. This index is meant to cover a broad measure of economic inputs to provide a clearer understanding of what is occurring in the overall economy.
For March the index ticked up to 30.16 from 29.96 in February. The bounce in the data can be primarily attributed to a surge in economic activity in the later part of 2012 and early 2013 due to Hurricane Sandy. However, recent data readings suggest that much of that activity has occurred and weakness in the underlying data is likely to return over the next few months at least. Importantly, readings below 30 have historically been associated with the onset of recessions.
The chart below displays the same data set but smoothed with a 6-month moving average in order to reduce the volatility contained in the underlying data. Again, it is quite clear that despite the ongoing commentary from mainstream analysts, and economists, economic activity has clearly peaked and is on the decline. The "Hurricane Sandy" effect is shown by the recent uptick in the data but the sustainability of that bounce is highly in question.
When viewing the data in this manner the question over the underlying strength, or weakness, of the economy becomes more easily answered.
STA Composite Employment Index (CEI):
The same analysis can be employed to garner an insight over the "great employment debate" which has been the focus of the current Administration and its policies, as well as, a direct focus of the monetary policies that have been implemented by the Federal Reserve. The CEI takes the employment components out of the indicators used in the EOCI which is then smoothed with a 4-month moving average. The chart is shown below.
Not surprisingly, and as has been witnessed by the recent spate of weaker than expected employment reports, employment peaked in early 2011.
While the current reading did tick up very slightly at the end of last year the current downtrend in the employment components of the major economic reports doesn't bode well for future employment reports. Furthermore, as shown, historically readings below 20 have normally been coincident with the onset of recessions.
The chart below shows the same index overlaid against the annual change in employment.
Not surprisingly the annual change in actual employment as reported by the BLS closely tracks the employment actions from the surveys contained in the employment composite. The sharp drop in recent months in the employment survey does not bode well for upcoming employment reports.
As first stated above - the purpose of these two composite indexes is to provide a broader overview of the trend of the economy and employment. Both of these are critically important in determining the current environment and the inherent risk being taken on by investors. What is clearly evident is that the economy is struggling in a very weak state and employment is lagging because of it.