Economic And Employment Composites Indicate Further Weakness
"The economy is amazing right now - employment is recovering, innovation is going and housing is reviving. What's not to love?" This was a statement I heard in the media to justify the recent rise in the stock market. In this past weekend's newsletter I went into significant detail in dismantling the bullish arguments with one point being the consistent weakness in the economic data.
The most recent release of the Chicago Fed National Activity Index (CFNAI) is the last of the components released each month that comprises the Economic and Employment Composite indexes. The April data for the CFNAI was not good with the manufacturing component confirming what we had already seen in most of the regional Federal Reserve manufacturing surveys. The overall CFNAI index plunged from to a negative 0.53 from a negative 0.23 in March. In both months, manufacturing production fell, down 0.4 percent in April following a 0.3 percent decline in March.
However, as opposed to recent media headlines boasting of the strength of consumer spending and housing, the consumer & housing sector was the second largest drag on national activity in April dropping from negative 0.15 in March to negative 0.17 in April. Employment also did not confirm the recent BLS report, which we suspected would be the case, as the employment component has fallen from a positive 0.35 in February to a positive 0.1 in March to ZERO in April. This is certainly not a trend that supports the much hoped for job growth in the near future.
Let's take a look at the two composite indexes to see what they are telling us about the economy and the most likely direction of the data in the months ahead. Both indexes are weighted average of the CFNAI, ISM, several Federal Reserve manufacturing surveys, the NFIB Small Business survey, Chicago ISM and the Leading Economic Indicators. The only difference between the two indices is that the employment composite is comprised of the employment components of the above as opposed to the overall activity components.
STA Economic Output Composite Index (EOCI)
The EOCI index fell sharply to 26.08 in April from 30.35 in March as the brief surge in activity from "Hurricane Sandy" finished working its way through the system. The chart below compares the EOCI index to real, inflation adjusted, GDP on a quarterly basis.
There are a couple of important takeaways with this index. The first is that both positive and negative trends in the EOCI index track very closely to the ebb and flow of GDP. The second is that historically when the EOCI index was below 30 the economy was either in, or about to be in, a recession. Currently, the economy is not running in recessionary territory, as of yet, but the trend of weakness in the macro economic data is somewhat concerning.
The chart below shows these corollary trends a bit better with the EOCI index, smoothed with a 3-month average, compared to the annual rate of change in nominal GDP.
What is most concerning is that while the asset prices are inflated with artificial interventions that trend of economic data has clearly peaked for the current cycle. Either the mainstream economists and analysts are correct and the economy is about to turn substantially stronger and play catch up with asset prices or asset prices will revert to catch up with the fundamentals of the economy. The latter is much more likely the case from a historical perspective.
STA Employment Composite
If you strip the employment components out of the EOCI index and weight them into their own composite index we find that the hiring intentions of employers is clearly weakening. The chart below shows the Employment Index smoothed with a 4-month average and compared to the annual rate of change in Total Non-Farm Employees.
As with the EOCI index above - employment activity clearly peaked in early 2012 and has begun to wane. The recent uptick in the employment index, remember this is a 4-month moving average, is due to the effects from the uptick in economic activity from "Hurricane Sandy." This index will turn down in the next couple of months as the recently monthly data points have declined.
What is clear from the two composite indexes is that the broad economy, and by extension underlying employment, has clearly peaked and has began to weaken. This is well within the context of historical trends and time frames. While the mainstream analysts and economists continue to have optimistic views for a resurgence in economic activity by years end the current data trends, both globally and domestically, suggest otherwise.
As we discussed recently:
"A wave of "disinflation" is currently engulfing the globe as the Eurozone economy slips back into recession, China is slowing down and the U.S. is grinding into much slower rates of growth. Even Japan, despite their best efforts through a massive QE program, cannot seem to break the back of the deflationary pressures on their economy. This is a problem that has yet to be recognized by the financial markets.
The recent inflation reports (both the Producer and Consumer Price Indexes) show deflationary forces at work. Wages continue to wane, economic production is stalling and price pressures are falling. More importantly, there are downward pressures on the most economically sensitive commodities such as oil, copper and lumber all indicating weaker levels of economic output. The battle against deflationary economic pressures has been what the Federal Reserve has been forced to fight since the financial crisis. The problem has been that, much like "Humpty-Dumpty", the broken financial transmission system, as represented by the velocity of money, can't be put back together again."
The real concern for investors, and individuals, is the actual economy. We are likely experiencing more than just a "soft patch" currently despite the mainstream analysts rhetoric to the contrary. There is clearly something amiss within the economic landscape and the recent decline in the economic, employment and inflation data are telling us just that.