The Return Of Economic Weakness
Here is a number for you: 70% That is roughly how many economic reports have missed their mark in the last month. Why is this important? Believe it or not - It has a lot to do with the weather. We have written many times recently about the weather related effects skewing the seasonal adjustment figures in everything from the leading indicators and retail sales to employment numbers. Now those weather related boosts are beginning to run in reverse as weather patterns return to normal and realign with the seasonal adjustments.
This resurgence of economic weakness is only just beginning to appear in the fabric of the various manufacturing reports. The Chicago Fed National Activity Index (a broad measure of 85 different data points) has declined from its recent peak in December of .54 to .33 in January and -.09 in February. The ISM Composite index (an average of manufacturing and non-manufacturing data), Richmond, Dallas and Kansas Fed Manufacturing indexes all posted declines in March.
This weakness has now shown up in our Economic Output Composite Index (EOCI) which declined in March to 36.53 from 42.08 in February. This decline marks the first decline since the August 2011 economic bottom that was created by the Japanese earthquake/debt ceiling/Greek default trifecta. The restart of manufacturing cycle, combined with pent up demand, unseasonably warm weather and more liquidity injections by the Federal Reserve and the ECB, boosted the economy sharply in the 4th quarter of 2011.
Last summer marks the second time in the history of the EOCI that the indicator fell below the 30 mark without the economy either in, or about to enter, a recession. Back in 1967 the economy struggled briefly before slipping into recession. The recent recovery from a sub-30 reading was a function of massive liquidity injections which created a "start and stop" recovery. While the hope over the last several months has been that the economy was beginning to recover on an organic basis - the reality is that as the current round of liquidity runs it course economic weakness will once again prevail.
However, while Wall Street may be fervently optimistic on the economy, Main Street maintains a different view. Recent data on the small business environment, as released by the National Federation of Independent Business for March, paints a similar picture to the EOCI index. While the NFIB index has grown in each of the last 6 months in March nine of the ten index components dropped with the most notable drop in hiring plans and expected real sales growth.
"March came in like a lion, with Main Street seeing significant job growth in March—but it appears to have gone out like a lamb, and with no cheer in the forward-looking labor market indicators. What could have been a trend in job growth is more likely a blip," said NFIB Chief Economist Bill Dunkelberg. "And what looked like the start of a recovery in profits fizzled out. The mood of owners is subdued—they just can't seem to shake off the uncertainties out there, and confidence that the management team in Washington can deal with the effectively is flagging. What we saw in March is painfully familiar – this was the same pattern of growth followed by months of decline from 2011. History appears to be repeating itself—and not in a good way."
The issue for small businesses is an interesting one. For them they are dependent ultimately on the consumer. Small businesses need sufficient demand from their customers to begin to increase permanent employment, expand facilities and produce more. This is why "poor sales" remains one of the primary concerns for small businesses and tracks closely with unemployment. The consumer, however, is dependent upon those businesses for employment in order to consume. This "tug-o'-war" keeps the economy from gaining the much needed "escape velocity" for an organic recovery.
However, this is where the weather related effect fills in the backstory. While consumer spending has been strong over the last few months, and has been a main driver of the recent recovery during that period, the weather had a huge factor to play in it. The unseasonably warm winter, the warmest in the last 65 years, provided a roughly $30 Billion dollar tax credit to consumers as heaters remained off driving normal utility costs lower. That effect, tied with the effective $60 billion tax credit from near $3 a gallon gasoline last summer, has provided a real boon to consumer's bottom line.
The warmer weather also allowed for a higher percentage of individuals to get to work that are normally absent due to inclement weather. Therefore, those individuals that depend on hourly wages for their labor had more income than usual to spend. It also provided a boost to construction and other manufacturing related jobs which are normally slowed by winter weather and required increases in temporary labor which boosted employment.
The latest employment report, which showed a sharp decline in job growth, also hints at the effect of the warm weather. The small increases in employment that are normally factored in by seasonal adjustments skewed the overall employment data to the positive. In the next couple of months as the seasonal weather patterns return to a more normal state, in Texas that would just be categorized as "hot", the seasonal adjustments will begin to realign themselves. This realignment will show up as a renewed weakness on the employment front an will raise concerns of a much weaker economic environment.
Furthermore, while we saw these weather related effects boost employment and consumption during the last few months which raised hopes of a recovering economy - those increases in consumption were not driven by stronger growth in disposable incomes. Incomes on a year over year basis have begun to decline and as a result consumption has growth through the expansion of credit and reduced savings rates. That trend is unsustainable longer term.
Whether were are talking about the consumer, housing or small business, the one link between all three is that they are still mired at very recessionary levels. Like a patient who has just come off of the operating table - the immune system is weak and extremely vulnerable to infection. The economy, much like a patient trying to come of life support, is extremely vulnerable to both internal and external shocks. The potential for another recession has actually increased in recent months even though it is not visible as of yet. There are far more headwinds than tailwinds today.
Markets don't run in one direction indefinitely - either up or down. The economy is a reflection of real employment, when you consider that 70% of the economy is made up of personal consumption, and ultimately the stock market is reflection of the economy. Therefore, while the markets and the real economy can detach from time to time, especially when driven by successive rounds of liquidity injections, reality will eventually play catch up with fundamentals. "Reversion" is the only truth that we can count on.