ECONOMIC DATA UNDERWHELMS THE MARKETS

The closure of the second quarter provided no respite for investors as the S&P 500 Index lost 12% and the Dow Jones Industrial Average was off 10%. Sellers remained in the spotlight once the quarter closed, leading the DJIA to a 4.5% loss on the week and the S&P 500 to a 5.0% loss over that same period.

Source: Econoday

Consistent with previous weeks, there was no single cause for the sell-off, but rather a number of economic releases suggesting an impending slowdown in the economic recovery.  According to Bespoke Investment Group, of the 21 economic releases last week, 14 were weaker than expected and only 7 outperformed.

The employment report was easily the most talked about as payroll employment fell by 125k.  The private sector added a lower than expected 83k jobs. Although the unemployment rate dropped from 9.7% to 9.5%, this was the result of 652k individuals electing to leave the labor force.  

Source: Reuters

More emblematic of the problem is the low employment to population ratio, which stands at roughly 58%, levels last experienced in the early 1980s, when the population was approximately 80mln less than it is today. 

Source: Center on Budget and Policy Priorities

The most interesting development during this recession has been the divergence in employment by age group.  After a devastating loss of wealth in 2008, the baby boomer demographic elected to postpone retirement, resulting in this group being the only one to experience net employment growth during this period. 

Source: Center for Economic and Policy Research

Personal income and spending turned in two of the better releases last week.  Personal income was up a robust 0.4% in May while personal spending was up a more tempered 0.2%.  The gain in personal income was the result of healthy increases to wages, a key indicator of a consumer’s ability to spend.  Personal spending would have been more robust if not for the fact that consumers elected to increase savings in an effort to readjust their balance sheets.  

Source: Econoday

 

ARE THE SIGNS AS BAD AS WE ARE LEAD TO BELIEVE?

At the start of the year, it was readily apparent that the economy was in a full-fledged recovery.  By the halfway mark, the questions are starting to reemerge. 

In recent weeks, commentators rang the alarm after the ECRI Weekly Leading Index plunged in to negative territory.  Many are taking this as a sign of an impending double dip recession, but this index has been notoriously susceptible to false positives over the course of its life.

Source: dshort.com

The ISM Manufacturing Index was also blamed as a harbinger of weaker growth after the index fell from 59.7 to 56.2 in May.  However, any readings above 50 indicate economic expansion from the prior month.  Also going largely unmentioned is the fact that a reading of 56.2 is better than 80% of the data points in the past 10 years. 

Source: Econoday

The other challenge with relying on an index such as the ISM is that the US manufacturing machine was long ago outsourced to China, India and points beyond.  Any perceived relationship between manufacturing growth and employment growth is as much coincidental as it is factual.  In the chart below we can see the declining prevalence of the manufacturing labor force.

Source: St. Louis Federal Reserve

The Baltic Dry Index (BDI) is adding to the worried state of affairs after falling for 27 consecutive days.  The BDI measures shipping rates around the globe and is seen as a reliable indicator of future economic demand.  Only paying attention to the headline figure is a misleading representation because recent movements in this index are largely being driven by a small subset of ships, namely capsize vessels.  These are the same ships used to transport iron ore, a favored commodity of the Chinese restocking engine in 2009.  With that economy approaching frothy levels, Chinese officials are reducing iron ore demand, at the expense of numerous ships that were brought on line last year. 

Source: Bloomberg

Almost entirely ignored, but easily more decipherable than any of the above mentioned indicators, is the spread between one-year and ten-year interest rates.  As the spread narrows, the probability of a recession increases.  At present, spreads are near their widest levels on record, as indicated by the recession probability chart below. In the post-war era there has only been one instance of a double-dip recession, in 1980 and 1981, but even during that period, the spread relationship inverted, foretelling the back to back recessions.

Source: Federal Reserve Bank of Dallas

While it is easy to remain pessimistic on the state of the economy, especially following the events of 2008, the signs of a double-dip recession are simply not there, yet.  Slower growth is a given at this point, but this should not come as a surprise considering that it has been well documented that previous stimulus would become a detractor to growth in the second half of 2010 and through 2011.  

Source: Goldman Sachs

Second half growth will slow from its already modest pace, but embracing the double-dip thesis is premature at this point.  Politicians are facing a difficult battle at the polls this upcoming election season and the likelihood that they want to explain a second recession

to their constituents is very slim.  Further stimulus packages are already being debated, even in the face of fiscal tightening by countries across Europe.

THE WEEK AHEAD

Investors return from the long holiday weekend with a relatively light economic calendar on tap.  Media reports will inevitably begin focusing on the analysis of the upcoming earnings season, which commences next week. 

On Tuesday, the ISM Non-Manufacturing Index will be reported.  The service sector is expected to remain well within expansionary territory although a slight slowdown is likely.  Consumer credit figures will be released on Thursday.  Following one month of expansion, consumer credit is once again expected to contract.

The Organisation for Economic Co-operation and Development (OECD) will release an assessment of the global employment markets on Wednesday.  

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