ISM Composite - Economic Weakness Returns
For the last six months we have continuously been discussing the economic strength seen in the last quarter of 2011 was largely transitory due to a skewing of the data caused by the unseasonably warm winter. We stated then that "What is important to understand is that while we had a rebound in some of the manufacturing reports in recent months there has been deterioration in the overall trend of the reports. Currently, the 3-month average failed to attain a new high post last summer's economic slowdown and now appears to be rolling over." Pay back has now arrived in everything from employment numbers seen last week to the manufacturing indexes..
Today's release of the ISM Non-manufacturing Index showed the services sector to have ticked up slightly to 53.7 from April's 53.5 read. The media headlines quickly jumped to report that "May Report Beats Forecasts" which does not really tell us much about where we are potentially headed.
One of our favorite indexes is the ISM Composite index which is an average of both ISM surveys. The composite index declined in May to 54.6 from 54.7 in April and 56.2 in March - do you see a trend here? There has been much talk about there being "no recession" in the economy soon due to the improvements in the last quarter of 2011 data. While the improvement in the data was certainly encouraging it is important to note that the composite index surged sharply to 55.4 just before the last recession. The index recently surged and peaked at 57.5 in March and has been on the decline since. Individual data points can be very misleading which is why we urge you to look at the trends of the data.
I am not saying that the economy is about to drop into a "recessionary state," however, the trend of the reports are certainly not encouraging. The chart of the Streettalk Economic Output Composite Index (EOCI) speaks to this point. The EOCI index is a composite weighted index of the Chicago Fed National Activity Index (a composite of 85 components), the ISM Composite Index, Chicago PMI, five major Fed regional manufacturing indexes and the NFIB Small Business Survey. By combining all of these individual indexes into one broad composite index we can more clearly see the trend of the economy as it is occurring.
In the chart I have noted each time that stimulus programs have been implemented and ended. With "Operation Twist" effectively winding down into June it is no surprise that the economy has began to falter as well. Interestingly, the decline last summer brought the index below the 30 level. This is the first time in the history of the index going back to 1974 that a dip below the 30 line was not coincident with a recession in the economy. The reason was the combined effects of a restart of manufacturing following the Japanese related shut down of auto production, the realization that the U.S. was not going to default as the debt ceiling debate ended, the tax cut of falling oil prices and the combined liquidity effects of "Operation Twist" and the Long Term Refinancing Operations. Those supports combined with the unseasonably warm winter weather led to a resurgence of economic activity which negated an immediate recessionary drag on the economy.
The reality, however, is that many of the supports were temporary in nature and have began to fade which answers the question we earlier posed this year as to the sustainability of the economic rebound. It is not. Just this past week domestic GDP growth was revised down to a paltry 1.9% annualized rate, employment is statistically not growing at all and a recession is firmly taking hold in the Eurozone. The concern is that any unexpected shock from the Eurozone will quickly trip the U.S. economy into recession as there is very little margin for error. The "fiscal cliff", which is the simultaneous expiration of many tax cuts and credits at the end of the year, will strip as much as 4% off GDP. Doing some simple math of 2% minus 4% gives you a very nasty recession in 2013.
Most likely we will see another stimulative program of some form by the end of summer as market and economic forces weigh on the Federal Reserve. Their battle against deflation is still being waged as the forces of a weak housing market, wages, employment and the economy still overpower other inflationary pressures. The problem that the Fed faces is that further stimulative action has less impact than the last. The Fed has warned that their ability to stimulate the markets, and the economy, is limited and that the Government must do their part to promote economic growth. We are now witnessing the limits of the Fed and Washington remains gridlocked in controversy. The outcome will not be a good one.
As we wrote in "3 Likely Triggers Of The Next Recession"; "...a recession is coming - recessions are part of the overall economic cycle and despite wishes, hopes and prayers, they will occur with a surprising level of regularity. During economic boom times they are spaced further apart due to stronger economic growth. During debt deleveraging cycles, such as we are experiencing now, they occur much more frequently. Furthermore, recessions are not a bad thing - they are simply the pause that refreshes the economy. As the economy, or the stock market, grows it creates excesses. These excesses must be reset from time to time through a contraction, or recessionary, phase. What is important to understand is the impact that recessions have on your life and your finances.
The recessions in 2001-2002 and 2007-2008 were important to prepare for, and we warned in our writings well before their occurrence — just as we are now. The problem for most individuals is that they did nothing to prepare of the event until it was far too late. Preparation such as taking an umbrella with you when you suspect that it will rain can save you from negative consequences. Understanding that a recession will occur and preparing accordingly will save you as well."
The trend of the economic data is clearly showing deterioration. A recession is coming — it is only a question of when and being properly positioned for it.