THE DAILY EDGE: 19 JULY 2019: Recession Watch

U.S. Leading Economic Indicators Decline

The Conference Board’s Composite Index of Leading Economic Indicators fell 0.3% (+1.6% y/y) during June following unrevised stability in May. It was the first decline in six months.(…) The decline in the Leading Indicators reflected lower readings for several component series. The readings for initial unemployment insurance claims, the ISM new orders index, building permits, the yield spread between 10-year Treasuries and Fed Funds fell. Offsetting these declines was improvement in the average workweek, consumer goods orders, new orders for nondefense capital goods, stock prices and consumer expectations for business & economic conditions.

Three-month growth in the leading index declined to -0.7% (AR), down from the high of 9.1% in December 2017.

The Index of Coincident Economic Indicators inched 0.1% higher (1.6% y/y) during June after a 0.2% increase. (…) Three-month growth in the coincident index improved to 1.1% (AR), but remained below 3.1% in December of last year.

The Index of Lagging Economic Indicators strengthened 0.6% last month (2.6% y/y) after edging 0.2% lower in May. (…) Three-month growth in the lagging index rose slightly to 1.5% (AR), but remained below 5.4% at yearend 2018.

The ratio of coincident-to-lagging economic indicators is sometimes considered a leading indicator of economic activity. It declined to the lowest level since early 1975.

Ed Yardeni illustrates what we all know, the economy is slowing below 2.0%:

The declining 12-m moving average of the LEI raises a yellow flag on recession probabilities…

…but the LEI has been going sideways since September 2018. A few more flat readings and the 12-m change will sink to zero. In fact, the 6-m change is flashing red (charts from Advisor Perspectives). Not red yet but it sure needs a rebound soon. It has had very few false signals in the last 50 years.

• US manufacturing flirts with recession despite output rising in June

US manufacturing output rose 0.4% in June, its biggest monthly gain since December, but the rise failed to prevent the sector contracting over the second quarter as a whole, dropping at a near-identical rate to that signalled by our PMI™ surveys. Both the official data and business surveys have indicated falling output for two consecutive quarters, meeting the technical definition of a manufacturing recession, though the surveys send contrasting signals for current growth momentum. More will be known with forthcoming flash PMI survey releases for July.

Official data from the Federal Reserve showed manufacturing production rising 0.4% in June, up for a second successive month after a sharp decline in April. However, given the scale of the drop in production in April, the latest rebound failed to lift output in the second quarter as a whole above that of the first quarter. Output consequently fell 0.6% over the three months to June compared to the first quarter, during which production had also slipped by 0.5%.

The two successive quarterly declines seen over the first half of the year broadly match those indicated in advance by the IHS Markit PMI as demonstrated by our first two charts. Applying a linear regression on the same raw data as the first chart, the second chart transforms the PMI diffusion index into a comparable three-month-on-three-month rate of change in the official data. The manufacturing PMI’s output index (note, not the headline composite PMI) is used as the sole explanatory variable of quarterly changes in the official manufacturing output data. The two series exhibit a correlation of 89% and a regression adjusted r-square of 0.788, illustrating the powerful predictive ability of the PMI, which is available almost one month ahead of the official numbers.

The big question of course is whether the improvement in the official data in June represents a turning point which will lead to stronger output growth in the third quarter.

A major development in recent months has been the deteriorating performance of larger companies in the PMI survey, where May and June saw the lowest large company PMI readings for a decade. After inventories rose sharply earlier in the year, large companies moved to destocking in May and June amid a sharp slowing in new order inflows. The weaker growth of larger firms compared to earlier in the year brings their performance more into line with small and medium sized companies (and incidentally likely explains the steep deterioration in recent ISM survey readings, as this survey focuses on large companies).

Although June saw a slight improvement in new order inflows compared to May, which matches the upturn in the official manufacturing output gauge, the past two months have seen some of the worst order book growth across the manufacturing economy since the third quarter of 2009. Such sluggish sales growth suggests that production growth will likely remain weak – at best – into the third quarter.

Companies themselves are also expecting a tough year ahead amid growing trade war tensions. IHS Markit’s Global Business Outlook survey found that a marked deterioration in sentiment in the US to the lowest since 2016 contributed to the gloomiest overall global outlook for output growth since survey data were first available in 2009.

The survey data therefore hint that the 0.4% rise in manufacturing output in June could represent a false hope of a strengthening production trend.

At least the consumer side of the equation looks ok, save autos.

U.S. Jobless Claims Rise The number of Americans applying for first-time unemployment benefits increased last week, but remained near historically low levels, a sign of a firm labor market.

Initial jobless claims, a measure of how many workers were laid off across the U.S., rose by 8,000 to a seasonally adjusted 216,000 in the week ended July 13, the Labor Department said Thursday. (…) A separate measure–the four-week moving average—fell by 250 to 218,750. (…)

Meanwhile, this sure looks like its going nowhere. Watch for the next Trump tantrum and a tweeted deadline before new tariffs hit:

U.S.-China officials discuss trade; Mnuchin eyes possible in-person talks U.S. and Chinese officials spoke by telephone on Thursday as the world’s two largest economies seek to end a year-long trade war, with U.S. Treasury Secretary Steven Mnuchin suggesting in-person talks could follow.

(…) “Right now we’re having principal-level calls and to the extent that it makes sense for us to set up in-person meetings, I would anticipate that we would be doing that,” Mnuchin told Reuters. (…)

“What they did was not appropriate,” Trump said Tuesday. “They are supposed to be buying farm products. Let’s see whether or not they do.” (…)

Derek Scissors, a scholar at the American Enterprise Institute think tank who has advised the White House on technology issues, said he expected further relaxations on Huawei to be part of any U.S.-China trade deal.

“The treatment of Huawei has been a circus,” he told a panel hosted by the Brookings Institution. “If we have a deal, Huawei will absolutely be part of it because the president doesn’t care … about technology competition.”

He said Trump was more focused on getting a trade deal and increasing access for U.S. farmers to Chinese markets.

Hence hopes rest on the Fed:

• St. Louis Fed’s Bullard Sees No Need for Larger Rate Cut Federal Reserve Bank of St. Louis President James Bullard said he would support a quarter-percentage-point cut in the central bank’s benchmark short-term rate at its July 30-31 meeting and doesn’t think a larger cut at that meeting is needed.

• Fed’s George Suggests She’s Not Ready to Cut Rates Federal Reserve Bank of Kansas City President Esther George said she’s prepared to be flexible, but she doesn’t yet see the case for a cut in interest rates later this month.

• Fed’s Kaplan Says Rate Cut Could Be Warranted Based on Bond Market Dallas Fed President Robert Kaplan said he could be convinced by arguments to cut rates based on signals coming from bond markets, even though he hadn’t penciled in any rate cuts this year at the central bank’s June policy meeting.

• Fed’s Evans Sees Two Rate Cuts Needed This Year Lower U.S. interest rates are needed to combat weak inflation, according to Charles Evans, the president of the Federal Reserve Bank of Chicago and a voting member of the central bank’s rate-setting committee.

• Fed’s Brainard Sees Case for Easing Monetary Policy Federal Reserve governor Lael Brainard said Thursday that easier monetary policy was justified in light of growing risks to the economic outlook and weak inflation.

and on

EARNINGS WATCH

There were 66 earnings reports in before yesterday. The beat rate is 80% (76% in Financials, 86% in Industrials) and the surprise factor was +4.6% (+4.8% in Financials, +2.5% in Industrials). Aggregate earnings for these 66 companies are up 9.3% on revenues up 2.4%.

Q2’19 earnings are now seen up 0.6% from +0.3% on July 1.

The new trend: “deconglomeratization”:

The reality is that return on capital for many large global conglomerates has been in secular decline for some time. Intensifying local competition in many sectors is certainly a major factor, but untimely acquisitions, shifts in regulatory regimes, and poor leadership are also significant contributors to what has emerged as one of the most favorable value creation opportunities for global private equity firms and thoughtful strategic buyers, we believe. (KKR)

• Budweiser Brewer to Sell Australian Unit to Japan’s Asahi Anheuser-Busch InBev agreed to sell its Australian unit for $11.3 billion, including debt, as it pushes forward with an effort to sell assets and pare debt after pulling an initial public offering of its Asia-Pacific businesses.

(…) AB InBev, which makes one out of every four beers sold world-wide, owns hundreds of brands in dozens of countries after a global buying spree that gave it Budweiser, Stella Artois and Corona. Those deals saddled the company with more than $100 billion in debt at a time when global beer sales are slowing. (…)