Manufacturing Not Showing GDP Strength
I wrote an article recently about the release of 3rd quarter GDP and why it was not the nirvana that most of the mainstream media were claiming it to be. While the premise of that article was focusing on consumer spending, or rather the cost of living consumption of it, I thought it was important to follow up with another concern that is brewing. Assuming that the jump in GDP from 1.3% in the second quarter to 2.5% in third, a 92.3% increase, was "real" spending by the consumer then you would expect it to show up in the manufacturing indexes. The problem is that it didn't.
Let's take a look at some of the numbers while remembering that 3rd quarter GDP was for the months of July, August and September. The chart above shows the status of the various reports during the three month period that corresponds to the GDP report. As you can see while there was some improvement in the numbers they were nowhere near the levels of increase that would correspond with such a massive increase in the GDP report.
Yesterday's release of the Dallas Fed Reserve region improved from a -14.4 in September to 2.3 in October which was the first positive move since April but order growth, backlogs and vendor performance all eroded pointing to weaker output ahead. The Chicago PMI, also released yesterday, came in down from last month's print of 60.4 at 58.4 which is back to where we were at the beginning of July. Like the Dallas release the internals of the Chicago PMI were mixed and doesn't bode well for continued growth going forward.
Today, we see the release of the ISM Manufacturing Index which declined from 51.6 in September to 50.8 in October. While new orders did pick up a little bit after three straight months of contraction during the boom of supposed consumption the reality is that we are seeing mild inventory restocking going into the retail shopping season. With the reality of what is happening overseas it will be very interesting to see how much of this actually gets passed through in the coming months. Furthermore, there is a fairly high correlation between the ISM and the year-over-year change in the S&P 500 which is pointing towards a weaker market ahead.
In the ISM report we saw prices paid slide 15 points to 41.0 which is the lowest reading in quite some time, however, this is reflective of slowing demand. With no real incentive to invest in business and workforces there will be immediate pressure to focus on cost cutting to offset slack in overall demand. As we have noted in the past the recent uptick in consumer spending was in food, utilities and medical bills which is why we aren't seeing it pass through to the manufacturing sector as robustly as one would expect.
The look for the retail shopping season is quickly dimming as you see wholesale jewelers seeing a lack of demand by their customers and Christmas clubs making a revival. The fragility of the retailer is closely linked to the frugality of the consumer. With the consumer dependent on government transfers for more than 20% of their income but with food and energy consuming 23% of wages and salaries the decision between necessities and luxuries really doesn't exist. This, of course, is not recognized by the analyst community who fail to see that the retail sector is doing everything they can from heavy discounts to credit extensions as well as price rollbacks to lure cash broke, credit constrained, consumers through the door.
What is further missed by the economists and the analyst community are the 10 concerns that we laid out yesterday. The issue that is not being discussed at all is the deficit cutting commission that will most likely fail to reach any agreement on spending cuts. This will in turn trigger the automatic cuts that are contained in the budget ceiling deal that was crafted this summer. The impact of these cuts could not come at a worse time and will likely throw the US economy into recession in fairly short order.
Given the fact that Europe is already on the brink of recession and China is slowing sharply there is precious little that can be done at this point that is likely to push off this fact. The Federal Reserve is meeting today and tomorrow and the markets will be glued to their announcement tomorrow looking for any clues of assistance from Ben. With Ben trapped between inflationary pressures that are already outside their comfort zone and political gridlock in Washington there is not a lot of room for him to work. However, a failure to another round of QE is likely to be met with disappointment by Wall Street who are dependent upon the support of the Fed to feed their liquidity needs.
We talked about our short term "Buy" signal last Friday but said: "The market has now cleared to key levels of resistance and now, on a pullback or consolidation that does not lead to a reversal of this rally, allows for an additional increase in exposure to portfolios." Today, those support levels are violated but it is the end of the week finish that is important to our signals. We recommend remaining on the sidelines until we can view our week end data in order to determine whether it is time for allocation changes. Caution is still highly advised.