On the News Front
Early in the trading session this past Friday (March 22nd) the 3-month Treasury bill yield & the 10-Year Treasury Bond yield inverted. As of this writing, the 3-month Treasury yield & the 10-yr yield are sitting at 2.455% and 2.442% respectively. Subsequently, this inversion took center-stage on the news outlets for the day. The ‘big deal’ associated with the inversion of the yield curve is that it has been a recurrence that has predicated (by roughly 1 year) the previous 7 U.S. recessions. So, while there has been debate throughout the past year as to the actual state of the U.S. economy, the inversion of the yield curve means the fear is beginning to become real. I figured, what better time to take a look at some of the economic leading indicators to assess, beyond the yield curve, what the economy is saying in regards to the economic cycle turning over.
Indicators in Focus
In one of my previous posts, here, I highlighted economic indicators as a whole & how they factor into ‘indicating’ the economic strength of the economy. I’ll list a variety of sources I grab releases and insight from, but mainly, I track most of the numbers tied to the economic indicators via Econoday. Over the past week, updates came in on PMI data, the housing market, Durable Goods (Factory Orders), jobless claims & also the FOMC forecasts, offering us insight into how they’re seeing the economy in its current state as well as in the short-term future. Throughout the week prior (Mar 11th-15th) we saw data released on retail sales, business inventories, small business & consumer sentiment, the CPI Index, and construction spending. In essence, the past two weeks have delivered us an update on the majority of the leading indicators I noted in my previous post while additionally delivering the FOMC forecast (that I believe needs to be taken with a grain of salt, no doubt.)
Week of 3.11.19-3.15.19
3.11.19 – Retail Sales & Business Inventories
Retail sales numbers are generally released with a 2-month lag. Meaning the retail sales numbers released on the 11th covered retail sales for January, even though we’re in March. The origins of these results come from the Monthly Retail Trade Survey sent out by the U.S. Bureau of the Census. The results of the release were a 0.2% increase in retail sales (on a monthly-basis) through January. This follows a 1.6% decline in retail sales in we saw in December.
As this graph illustrates, retail sales can be seasonal. Many expect slowed spending in January as consumers tend to overspend in December with Christmas hitting everyone’s wallet hard. So, with that in mind, what is seemingly more telling in this past graph is the relatively big 1.6% decline in retail sales in December. When we look at the yearly line, we can see that since roughly past July, the year-over-year change in retail sales seems to be declining, which can be concerning if it doesn’t turn around. An interesting causation to consider is the impact of the tax-cuts over the past year. When considering the impact of 1-time bonuses many across the corporate sector received at some point last year, coupled with the decline in tax rates that many employees expected to benefit from (& subsequently did not), it is not hard to believe these factors would have played into further fueling spending throughout the year. However, we cannot forget the credit bubble. With consumer credit at all-time highs within the U.S., it has been a matter of time as to when that would reach its limit for many. The year/year trend line may be illustrating that cycle is turning over. The concern here will obviously be when that year/year trend line hits 0.0% or dips below, as that would be illustrating NO growth in retail sales on a year/year basis as retail sales would contracting instead.
Business Inventories numbers lag by 3-months and report on a month-over-month basis as well. Inventories increased in December by 0.6%, pretty much in line with expectations. However, this is not to be taken simply at face-value. Econoday taught me a while back to analyze business inventories in relation to sales. The concept makes sense, as businesses tend to accumulate their inventory in correlation to the sales they expect to have in the future. Considering that, inventories rose 0.6% in December against a 1.0% drop in sales. That increase of inventories vs. a drop in sales would seemingly point to businesses sales expectations being more optimistic than what the reality has ended up being. This issue of diverging inventory growth vs sales growth has been occurring throughout the past year. On a year-over-year basis, total inventories have grown 4.8% while sales (manufacturers, wholesalers, and retailers) have only grown 2.1%. It wouldn’t surprise me, now that holiday season has passed, if we see business inventories scale back considerably seeing as how retail sales appear to be considerably slowing. Lastly, it is important to note that inventory growth immediately benefits GDP numbers but a growing gap between inventory and sales that persists will end up creating a need for inventory liquidation, which would negatively affect future GDP and also employment as companies cut back on costs to compensate.
3.12.19 – Consumer Price Index (CPI)
CPI numbers report the past month’s results & are reported on a month/month basis. CPI measures the change in the average price level of a specific basket of goods and services for consumers. CPI is important as an indicator because many consider the CPI to be a proxy for the rate of inflation for consumers. From a month/month basis, February registered a 0.2% change to the CPI. This follows a 0% change in January. On a Y/Y basis, February registered a 1.5% increase to the CPI. When we consider CPI being a proxy of inflation, it’s not surprising the Fed and forces that be consistently micro-manage the variables they can related to the CPI, consistently leading the CPI to demonstrate small changes on a M/M basis. Note, the Feds inflation target is 2%, so this year/year rise of 1.5% is largely in-line with their target. In looking at the year/year change to the CPI;
We can see the CPI appeared to peak around July of last year and has been declining similar to what retail sales illustrated above. Wrapping together this declining inflation since mid-2018 with the correlated decline in retail sales (a notable portion of the economy’s overall demand), the trend appears to be on the decline. Contracting demand certainly can precede a contracting economy. Lastly, with inflation seemingly under the Feds target rate, and consumer demand demonstrating a slowing trend, it comes as no surprise that the Fed decide to call off the planned rate hikes throughout this year & have demonstrated a much more dovish stance since December than we had seen previously. I expect that wouldn’t change so long as the trend continues.
3.13.19 – Construction Spending (2mo Lag)
Construction spending considers new construction activity on residential, non-residential, and public projects. This is of importance to the state of the economy as it relates to real estate spending as well as is has relation to overall economic growth. As a city, state, or economy grows, it’s easy to expect that that growth will need new buildings, homes, etc. to accommodate that growth. To that point, construction spending has consistently been correlated closely with economic growth and contraction. On a M/M basis, construction spending in January had a 1.3% jump which exceeded expectations, but followed a -0.8% decline in spending seen in December. 
In looking at construction spending from a year-over-year basis, we see the same contraction in spending throughout the 2nd half of 2018, that retail sales demonstrated above. This contraction further suggests a slowing economy. With December illustrating the first flip on the graph to a decline in spending, followed by January being the smallest growth % on the graph (especially when compared to January 2017 & 2018) it certainly seems like residential spending is about to begin a contraction of its own. Also, to consider, is that the 1.3% jump in January doesn’t include new single-family homes which faced a 7.2% Y/Y decline in spending. If included, it can be assumed that would have significantly dropped the 1.3% decline. Also, important to note, multi-family construction spending seems to be on an uptrend with January reporting a 12.8% increase in spending. This decline in single-family homes, coupled with a continued increase in multi-family homes may be important to watch going forward. I’ve speculated over the past year that residential real-estate has been changing exponentially over the past 5-10 years towards rental properties becoming the ‘norm’. This speculation is tied to this divergence in residential construction spending along with the multitude of reports on millennials not being able to buy homes, the majority of the economy saddled to the brim with debt, and wages having the hardest time rising over the past 5 years. All of these factors are certainly headwinds to economic growth.
3.15.19 – Consumer Sentiment (Preliminary results for March ’19)
Consumer sentiment index results rely on survey responses sent out to ~600 households each month on their financial condition as well as their attitude about the economy. Consumer sentiment is important to analyzing the state of the economy as it has a direct relationship to the strength of consumer spending. If consumers think things will be great going forward, they’ll tend to spend more. If they believe things are looking gloomy, they’ll tend to pull back their spending in the face of economic uncertainty. This month reported a 97.8 level for consumer sentiment. This follows a level or 93.8 for February. This jump isn’t surprising, as humans can be short-term thinkers. When we look at things from a comparative stand point, the government shutdown had been resolved towards the start of last month and news of the trade war issue being optimistic as of late, it’s no surprise we’ve seen a jump in consumer sentiment this month and last. From a comparative point-of-view, things aren’t looking quite as sketchy as they had seemed in January. This increased consumer sentiment could certainly lead to increased spending throughout this month. However, if consumer sentiment is at these levels, but the results of consumer spending end up not falling in line, that would certainly indicate depressed consumer spending is the result of uncontrollable factors (debt levels, cost of living increases taking up consumers discretionary spending budget, etc.) rather than a lack of desire by consumers to spend.
Week of 3.18.19-3.22.19
3.18.19 – Housing Market Index (Mar 2019)
The results of the Housing Market Index were intriguing. March’s results were in line with February’s results, illustrating no change in the housing market. However, the interesting part seemed to be that this lack of recovery for the housing market wasn’t due to a lack of sales, rather it seemed to be due to a lack of ‘average’ buyers. Currently, it seems that sales in the housing market are currently being driven by high-end buyers, while the results illustrate a lack of interest in home purchasing for the average & 1st-time buyer. Importantly, the current level over the past 2-months is at the highest it has been since October, where the housing index subsequently saw a sudden drop in November with a continued drop into December. If the macro-level of uncertainty continued to persist and other indicators continued to decline, it would not be a surprise to see a sudden drop again in the housing market.
3.19.19 – Factory Orders (DGP – Jan 2019)
Factory orders consist of new orders for both durable and nondurable goods. This is important because it gives us an idea of the demand trend from the manufacturing perspective. January resulted in a 0.1% increase in factory orders. This follows a 0.1% increase in December as well. In short, demand at the manufacturing level has been pretty level. This position is further illustrated in the yearly graph. 
As we can see, factory orders were on the increase throughout 2017, but seems to have peaked around mid-2018 in line with the peak seen in retail sales and the reversion of the CPI. When we also factor in the decline the global economy has been illustrating and trade-war issues continuing to persist, it will come as no surprise when factory orders continue to decline.
3.21.19 – Jobless Claims (for week of 3.16.19)
Jobless claims differentiate to the degree they are reported on a weekly-basis rather than on a M/M basis. Unemployment claims are important to analyzing the state of the economic cycle as they give us ongoing insight as to how employment situation is going for employees on a macro-level. An increasing trend in unemployment claims suggest a deteriorating labor market while a decreasing trend suggests an improving labor market. For the previous week, 221,000 new unemployment claims were reported. This follows 230,000 claims in the previous week. These numbers illustrate a generally stable level in the short-term. However, when we look at unemployment claims from a Y/Y perspective; 
We can see there’s a possibility the declining trend seen throughout 2017 has begun a reversal. Also interesting to note, it interesting that this reversal seems to have begun around the same time period that retail sales began to decline. I’d expect that if we see a resolution to the trade-war issue come to be, this number could continue a decline as demand is boosted temporarily. However, as news on the trade front has become murky as of this past week, a lack of resolution would likely lead to a continued increase in jobless claims, further indicating an economic slowdown is occurring with the possibility of a recession incoming.
Conclusion
While a recession doesn’t seem to be on our doorstep (i.e. likely within the next 3-5 months), it certainly seems to be fact that the U.S. economy has faced an economic slowdown since mid-2018. The market’s response in December and correlated influx of earnings misses prevalent in Q1 of 2019 seem to further this conclusion. While not every leading indicator is flashing red/yellow lights (Consumer Sentiment), it’s apparent that the majority have been flashing yellow (Retail Sales, Jobless Claims, Factory Orders) since mid-2018 with some beginning to flash red (Construction Spending, Housing Index). With these factors in mind, it is always important to realize how things have been is not how they always will be & where we are now indicates not where we will be to be in the future, but more-so, what direction we are headed.
Until next time,
ZSV
Disclaimer
This report is provided for informational purposes only and does not constitute investment advice to buy or sell an interest in any securities.