Global economic update: stabilisation but no recovery

Posted on Friday, August 2, 2019 at 02:49PM by Registered CommenterSimon Ward | CommentsPost a Comment

The long-standing forecast here has been that global industrial momentum would reach a low around Q3 2019. The latest business surveys are consistent with this forecast.

The global manufacturing PMI new orders index edged up in July, while the difference between the orders index and an average of inventory indices for inputs and finished goods – a leading indicator – rose to a five-month high.

The suggestion that the negative impact of the stockbuilding or inventory cycle is peaking is supported by national business surveys. The second chart shows the contribution of stockbuilding to G7 annual GDP growth along with a proxy indicator derived from national surveys (ISM, Ifo, Insee etc). The contribution was still significantly positive in Q1 but the indicator points to a large drag in Q3 / Q4. Its current level is consistent with the stockbuilding cycle moving into a low.

The business surveys feed into the OECD’s widely-watched leading indicators. The OECD will release June indicator data (incorporating the July survey results) on 8 August. With most of the component information available, an independent calculation is possible. The G7 leading indicator is estimated to have fallen further in June but the pace of decline continues to slow – third chart. The six-month change bottomed in February, consistent with a low in six-month industrial output momentum in Q3, based on an average five-month historical lead

The above observations are not intended to suggest that an economic turnaround is imminent. Near-complete June monetary data confirm an earlier estimate that global six-month real narrow money growth remained beneath its recent February high of 1.9%, at 1.8% –  fourth chart. The judgement here remains that a rise to 3% is needed to signal an economic recovery. The current message is that economic weakness will persist through Q1 2020, at least. A fall below the November 2018 low of 1.1%, of course, would negate the view that economic momentum is in the process of bottoming.

An additional reason for caution is that the business investment cycle appears further from troughing than the stockbuilding cycle. The annual rate of change of G7 business investment, while falling, was still significantly positive in Q1, with sluggish profits suggesting weakness – fifth chart. The investment downswing may not bottom until Q4 or Q1 2020, by which time the annual change is likely to be negative.

The suggestion of further investment weakness is supported by the sectoral breakdown of the global manufacturing PMI new orders index, with the investment goods component falling to a new low in July – sixth chart.

The resilience of consumer goods orders accords with the cycle analysis, which interprets current economic weakness as producer-driven – i.e. due to the stockbuilding and business investment cycles. Consumer-led downturns are driven by housing busts but the housing cycle remains in a longer-term upswing. Consumption momentum, nevertheless, is expected to fade over coming quarters as unemployment moves higher.

US profits revision suggesting weaker outlook

Posted on Tuesday, July 30, 2019 at 03:48PM by Registered CommenterSimon Ward | CommentsPost a Comment

The big news in last week’s US GDP release was a huge downward revision to corporate profits growth in recent years.

The national accounts measure of post-tax “economic” profits – adjusted for stock appreciation and to reflect “true” depreciation of capital assets – was revised down from $2,031 billion to $1,855 billion for 2018, a cut of 8.7%. Profits in Q1 2019 were unchanged from Q3 2014 – see first chart.

The downward revision reflected the incorporation of comprehensive annual data from corporate tax returns. The cut in profits was balanced by upward revisions to employee compensation and net interest costs.

Last year, some analysts cited strong growth of national accounts profits as a reason for economic optimism. A post at the time warned that early national accounts numbers were often revised significantly. Real-time profits were rising immediately ahead of the last two recessions but the numbers were subsequently revised to show falls.

The business sector was previously reported to be a net lender to the rest of the economy in Q1 2019, with saving exceeding investment by 0.9% of GDP. The new data show a deficit of 0.8% of GDP – second chart. This excludes borrowing to finance net equity retirement – 3.5% of GDP in Q1.

The weaker financial position than previously reported supports the pessimistic view here of prospects for business investment and employment.

The new national accounts profits numbers show a marked divergence from S&P 500 operating earnings. The latter rose by 57% from a low in Q4 2015 through Q1 2019 versus an increase of only 13% in the national accounts series – third chart.

One reason for the difference is that the national accounts series encompasses smaller and unquoted companies – S&P 500 operating earnings are equivalent to about two-thirds of the national accounts total. Profits of these smaller firms may have been underperforming.

The national accounts series measures income from current production, excluding non-recurring items such as capital gains / losses, restructuring charges and bad debt provisions. While the definition of operating earnings is similar, the adjustments made by S&P may be less comprehensive and rely on data provided by companies in their financial statements rather than tax returns.

A similar large divergence between S&P 500 operating earnings strength and stagnant or falling national accounts (revised) profits occurred ahead of the 2001 and 2008-09 recessions and was “resolved” by a subsequent decline in S&P earnings.

Euroland PMI weak but money trends still hopeful

Posted on Wednesday, July 24, 2019 at 12:30PM by Registered CommenterSimon Ward | CommentsPost a Comment

The Euroland manufacturing PMI fell further in July but the view here remains that the index is bottoming, based on the leading signal from a rise in six-month real narrow money growth since late 2018 – see first chart.

Real money growth, admittedly, slipped back in June (data also released today) but this mainly reflected a further pick-up in six-month inflation, which is probably peaking – second chart. Nominal narrow money growth has moved sideways recently.

Real narrow money growth remains stronger than in other major economies.

The further fall in the PMI may have been driven by firms paring excess inventories, resulting in a reduction in orders on suppliers. Orders will normalise higher when this process ends – even with unchanged final demand. This could be imminent: the ratio of new orders to inventories remained above its recent low in July despite the further decline in orders.

While industrial momentum could be bottoming, the latest money numbers suggest a subdued economic outlook, implying softer labour markets and a continued inflation undershoot. The composite PMI, moreover, could decline further as services catch up with manufacturing weakness.

Country data show that real narrow money growth remains stronger in France and Spain than Germany, suggesting superior economic prospects – third chart. A sharp rise in Italian growth in June mainly reflected a positive base effect and should unwind next month. 

US C&I loans confirming inventory downswing

Posted on Tuesday, July 23, 2019 at 10:16AM by Registered CommenterSimon Ward | CommentsPost a Comment

Three-month growth of US commercial bank loans and leases fell from 1.5% (6.3% annualised) in February to 0.9% (3.5%) in June, reflecting a sharp slowdown in commercial and industrial (C&I) lending – see first chart.

The demand for C&I loans is closely related to the stockbuilding or inventory cycle. The lending slowdown adds to other evidence, discussed in Friday’s post, that the US / global cycle is weakening rapidly towards a low likely to be reached during the second half of the year.

The second chart shows the contribution of stockbuilding to annual GDP growth together with the annual change in three-month growth of C&I loans. The relationship suggests that the change in inventories will be a significant drag on Q2 GDP, to be released on Friday.

The Q2 report will incorporate annual revisions, which may resolve the recent large divergence between the headline (expenditure) and income measures of GDP. According to current data, headline GDP rose at a 2.6% annualised rate in the fourth and first quarters combined versus growth of only 0.8% in the income measure – the latter weakness is consistent with a stagnation of real narrow money in the year to November 2018.

Global economic update: beware "false dawn" PMI bounce

Posted on Friday, July 19, 2019 at 10:55AM by Registered CommenterSimon Ward | CommentsPost a Comment

As discussed in Tuesday’s post, global narrow money trends suggest that economic momentum will bottom out in the third quarter of 2019 but remain weak into early 2020.

The monetary signal has been confirmed by a global non-monetary leading indicator based on the OECD’s country leading indicators. The six-month rate of change of this indicator appears to have bottomed in early 2019 and typically leads by 4-5 months – see first chart.

Neither money trends nor the leading indicator are yet suggesting an economic recovery, in the sense of a return to trend growth.

A further reason for expecting economic momentum to bottom out around the third quarter, discussed in previous posts, relates to the global stockbuilding or inventory cycle, which averages 3.5 years in length, i.e. measured from trough to trough.

The second chart shows the contribution of stockbuilding to annual G7 GDP growth. The last trough occurred in the first quarter of 2016, suggesting another low in the third quarter of 2019, assuming that the current cycle is of average length.

The growth contribution was still significantly positive in the first quarter of 2019 – the last data point in the chart – raising the possibility that the current cycle will be longer than average, implying a later trough.

However, two pieces of evidence suggest a rapid weakening in recent months – a third-quarter low, in other words, remains plausible.

First, an indicator derived from G7 business survey responses about inventories correlates with the GDP stockbuilding data but is more timely and sometimes leads, and this indicator turned significantly negative in early 2019, though has yet to reach an extreme suggestive of a cycle low – third chart.

Secondly, global retail sales volumes have rebounded strongly since end-2018, far outpacing industrial output – fourth chart. This suggests a significant drawdown in inventories unless spending on capital goods has collapsed.

Retail sales strength is likely to fizzle. It partly reflects a US bounce-back after weakness associated with the government shutdown. In addition, a fall in sequential inflation was a tailwind during the first half but is now reversing. Softening labour markets, meanwhile, are starting to erode consumer confidence.

The forecast of a trough in global industrial momentum in the third quarter suggests that the global manufacturing PMI – a coincident indicator – is at or near a low. The forthcoming July flash results, moreover, could reflect some hope engendered by the Trump-Xi trade truce in late June – this may have influenced yesterday’s stronger Philadelphia Fed manufacturing survey.

The danger is that markets and policy-makers wrongly interpret a bottoming of the manufacturing PMI as a precursor to an economic recovery in late 2019 / early 2019 – ignoring evidence from monetary trends and other leading indicators that prospects remain worryingly weak.

A rebound in bond yields as expectations of central bank policy easing are reined back would risk aborting the recent tentative monetary recovery. It could also trigger another sell-off in equities, which have displayed a strong inverse correlation with real yields in recent months – fifth chart.