Forecasts that the U.S. is headed into recession took another lump from the economic data with today’s release of the Labor Department’s report on initial claims for unemployment. For the week ended on February 13, new claims for unemployment fell by 7,000 to seasonally adjusted 262,000. That’s the lowest level of initial claims since November and below the projection of 275,000 new claims by economists surveyed by Reuters.
The four-week moving average, a less volatile read on the underlying trend, fell by 8,000 to 273,250 with last week’s report.
Again, no evidence from this report that the U.S. economy is about to shift into higher gear. But also no evidence that the economy is sliding toward recession.
Is this kind of indicator of modest growth enough to reassure the Federal Reserve about the underlying strength in the U.S. economy so that the Fed raises interest rates once or twice in 2016? That’s the big question right now since the market decided a week or two ago that the Fed wouldn’t raise interest rates at all in 2016 and that the first increase might not come until relatively late in 2017. It doesn’t take much in the way of economic strength–an upside in industrial growth yesterday and slightly stronger initial claims numbers today–to raise doubts about that consensus.
All it takes is a little doubt when the market isn’t pricing in any doubt at all.
Most technical indicators say we’re in a bear market. Whether you want to call it a rolling bear, or a consolidation, or pick nits since the Standard & Poor’s 500 as a whole hasn’t yet hit the down 20% territory now inhabited by many of former market leaders. (The February 12 issue of James Stack’s InvesTech Research newsletter does a superb job of summarizing the technical indicators pointing to a bear market. To check out Stack’s newsletter and/or subscribe go to investech.com)
But so far economic indicators aren’t pointing to a U.S. recession. Job growth and income growth are healthy. Although the Institute for Supply Management’s survey of purchasing managers in the manufacturing sector has fallen below the 50 mark that indicates contraction in the sector, the survey for the services sector hangs above that mark, despite recent weakness. In the housing sector the confidence survey for the National Association of Home Builders hasn’t shown the downturn that usually proceeds a recession.
This is a good moment to remember Nobel-prize-winning economist Paul Samuelson’s quip that “The stock market has forecast nine of the last five recessions.”
Why is this important?
Stocks can certainly experience a bear market without a recession so the fact that the economy may not enter a recession isn’t some kind of proof that stocks aren’t actually in a bear or headed for one. (The S&P 500 is hanging around a drop of 13% or so in a bad week–not bear market territory–but 60% of S&P member stocks are 20% or more off their highs.)
But the worst bear markets in terms of percentage drop and in terms of duration require a coincident recession. If the U.S. isn’t going to slide into recession, the bear that is breathing down our necks right now will probably resemble a deeper version of the 12.4% drop from the May 21 high of 2130.82 on the S&P 500 to the August 25 low at 1867.61.
By November 2 the S&P 500 had climbed back to 2109.79. Painful certainly but not terribly long-lasting.
To get a really, really painful and long-lasting bear you need to combine a drop in stock prices with a recession as we did in 2007, 2000, and 1980. The 2007 bear–and the Great Recession–took stock prices down 56.8% and lasted for 517 days, according to Yardeni Research. The 2000 bear resulted in a 49.1% drop and lasted for 929 days. The 1980 bear took stocks down 27.1% and lasted 622 days.
Now that’s pain–and the duration of that pain was enough to test–if not wash out–even the most steel-nerved of investors.
So the big question for 2016–after the horrendous start to the year–is will we get a U.S. recession in 2016?
I wish I could confidently scoff and say “No way,” but I can’t. I think a U.S. recession in 2016 is unlikely–but it certainly isn’t impossible.
The economy, I’m afraid could go either way–although I think the odds are in favor of “No recession.”
As I noted above job growth is very solid and income growth actually looks like it is starting to pick up. Low oil prices mean low gas prices mean more dollars in consumers’ wallets for spending on things other than fuel. The U.S. auto industry set a sales record in 2015 and doesn’t look poised to fall off a cliff in 2016. After it’s best year in a decade in 2015, the U.S. housing industry is forecast to see 1% to 3% sales growth in 2016. That’s not a house on fire but growth isn’t recession. U.S. interest rates are low–and I think it’s likely that the Federal Reserve will pause its rate increases until it sees signs that U.S. growth is a solid 2% or so. Right now forecasts call for earnings growth to resume in the second half of 2016 as year-to-year comparisons with the slow growth of the second half of 2015 make beating estimates easier. That would have a big positive effect on CEO confidence levels. That’s important because worried CEOs fire people and don’t invest in their businesses. A modest increase in oil prices to, say $45 a barrel, would take pressure off some oil companies and reduce worry over banks’ exposure to bad loans in the energy sector.
That’s not a forecast for rip-snorting economy in the second half of 2016–but it is a picture of an economy that isn’t in recession.
Unfortunately, none of those positive trends or news items is a lock. China’s economy, despite the current round of stimulus, is likely to continue to slow. The U.S. economy doesn’t look like it will get any help from Japan and a EuroZone growth recovery is possible but questionable and won’t produce big numbers in any case. Developing economies and commodity-oriented economies such as Australia and Canada are likely to struggle. There is the possibility of a beggar-thy-neighbor round of currency devaluations that would further hurt U.S. exports. We’ve got weak governments coping with big problems in the EuroZone, the Middle East, Russia, and Japan. And I certainly would never rule out that U.S. politicians might be something stupid in an election year that might hurt U.S. growth. Nor can I absolutely rule out the possibility that the Fed got it wrong when it decided to raise interest rates in December.
It’s going to be hard to tell what the economic trend line is over the next few months because beginning in March we’re likely to see splashy moves from the central banks of the EuroZone, Japan, and China. I think all three of these central banks are signaling that they will move strongly in the early spring to stimulate their own economies. The likelihood is that will rally stock markets for a while but then leave markets open to a return to the crisis of confidence that I see in the financial markets right now. To my eyes a big part of the current slide in global stocks markets is due to investors and traders losing confidence in the ability of central banks to produce growth in their economies or to prop up the prices of financial assets for very long. That could see us return to the current malaise after the failure of a promising rally in the spring. That kind of volatility will make it very hard to find a longer-term trend worth hanging onto.
I guess you could color me “hopeful” that the U.S. will avoid a recession–which would help investors avoid the worst kind of bear market–but worried that a recession is possible and that financial markets having lost faith in central bank policies will wander lower.
In absolute terms the addition of 151,000 jobs to the U.S. economy isn’t a great number. It was below expectations from economists surveyed by Bloomberg for 190,000 jobs and it was a big drop from the 262,000 jobs created in December and the 280,000 added in November.
But in the context of a bond market that had just about concluded that the Federal Reserve couldn’t afford to raise interest rates even once in 2016, 151,000 is enough. Especially when you add in strong growth in hourly earnings and a drop in the official unemployment rate to 4.9%, the lowest level since February 2008.
Some doubt about the Fed’s moves for 2016 crept back into the market this morning, As of 10:20 a.m. New York time the yield on the U.S. 10-year Treasury had climbed 3 basis points–not much but any move upward breaks, so far, the recent trend downward. (And remember bond prices go down when yields go up.) The U.S. dollar was up 0.4% against the 10 currencies tracked in the Bloomberg Dollar Spot Index.
The most important number in this morning’s report from the Labor Department, in my opinion, was the gain in hourly earnings. Average hourly earnings rose 0.5 percent from a month earlier. That took the year over year increase to 2.5%. That follows a 2.7% year over year growth rate for average hourly earnings in December. The two back to back readings of 2.5% and 2.7% certainly suggest that moderate wage growth is now the rule. That in turn is positive news from the Fed’s efforts to get inflation to 2% and gives the central bank some reason to believe that another interest rate increase won’t completely derail inflation or the economy.
I think these numbers are likely to leave the Fed very cautious. The Fed’s Open Market Committee doesn’t meet until March 16 so Janet Yellen & Co. will have February data and a look at early March numbers before they need to decide anything. There’s still a way better than even chance in my books that the Fed will opt to gather another month of data, which would put off the decision until the April 27 meeting or, since the April meeting doesn’t currently include a press conference in its schedule (and the Fed likes to make moves in interest rates at meetings with press conferences,) the June 15 meeting.
None of today’s news or my speculation above suggests that the Fed will aggressively raise interest rates in 2016–the earlier suggestion of four rate increases in 2016 still seems unlikely. But today’s news does introduce an element of uncertainty into a bond market that had been increasingly convinced that 2016 was “one-or-none.”
The “one or none” trade includes a little more risk this moaning
Is the Fed’s latest revision of its economic model pointing to a December increase in interest rates?
The decision on when the Federal Reserve will start to raise interest rates may rest with something called the output gap. And the most recent revision of an economic model at the Fed points to a December increase in rates because the output gap in the U.S. economy is projected to close in early 2016.
The Fed has released an updated version of the model of the U.S. economy put together by its staff. One key point in the model is a calculation of the speed limit for the U.S. economy. The speed limit is a projection of how fast the U.S. economy can grow before it uses up all the slack in the U.S. economy and starts to create inflation.
The newest revision puts the point where the economy will have used up that slack in the first quarter of 2016. After that quarter any increase in the speed of growth would create scarcity in such resources as workers and raw materials. What economists call the output gap—the difference between what the economy is producing and what it could produce without causing inflation—would have closed.
The newest revision of the Fed’s model of the economy estimates the economy’s speed limit at just 2% at an unemployment rate of 4.9%. The economy grew at a rate of 1.5% in the third quarter as companies reduced inventories. Real final sales, a measure of growth in the economy that excludes changes in inventories, grew at a 3% rate in the quarter. The official unemployment rate was 5.1% in September.
The approach to the point where faster growth would lead to inflation, according to the latest revision in Fed’s economic model, would certainly justify an increase in interest rates. Federal Reserve members have repeatedly noted that the time to raise interest rates is before inflation hits the Fed’s target of 2%.
If Federal Reserve policy is indeed “data-dependent” right now, this data point is signaling December.
What a week for potentially market-moving news!
Let me give you a quick run down, ok?
Monday: Beginning today and running through Thursday, the Central Committee of the Chinese Communist Party meets to formulate a new 5-year plan that would go into effect in 2016. Certainly on the agenda are a new target for economic growth, reforms for the country’s huge state-owned enterprises, and goals for continued urbanization, environmental regulation, and registration for China’s migrant workers. The goals aren’t actually released until ratified by the national legislature, which meets in March, and typically they don’t go into official effect until the fall. But while remaining officially unimplemented, many parts of China’s government start to react as soon as the meeting is over. That’s especially true of monetary authorities such as the People’s Bank. China’s central bank cut lending rates at the end of last week in anticipation of this meeting, but there’s still room for more moves on mortgage rates and restrictions, and bond issuance by local governments, just to name two issues. The Shanghai and Shenzhen markets were up modestly overnight (0.5% and 0.68%, respectively) in anticipation of the meeting.
Tuesday: Call it a preview of Thursday’s report on third quarter U.S. GDP growth. Wall Street is expecting a 1.3% drop in orders for durable goods for September. That would be an improvement from an even bigger decline in August. Look to see what the figures ex-aircraft show since a shift in the timing of one or 10 of these big-ticket orders can skew the entire top line of the report. Anything worse than Wall Street’s expectations will color opinion ahead of the GDP report.
Tuesday: It’s Apple (AAPL) day. The company reports revenue and earnings for its fiscal fourth quarter. Key issues will be sales of the new iPhone, where analysts will be looking for any signs of weakness in the launch, and sales in China, where they will be looking for signs that slowing growth in the Chinese economy has cut into sales. Apple CEO Tim Cook has repeatedly said that Apple isn’t seeing problems in its China results—that may have created expectations that could bite the company this quarter. I think Apple’s results this quarter are likely to have more effect on the market as a whole—where investors will look for clues to growth in the Chinese and global economies—than for technology stocks. Still watch for reaction from shares of Apple’s suppliers such as Analog Devices (ADI), Qualcomm (QCOM), and Synaptics (SYNA.)
Tuesday: More on strength or weakness in the U.S. economy when Ford Motor (F) reports third quarter earnings. (General Motors (GM) reported last week and showed a larger-than-expected gain in operating profits in North America.) Of particular interest at Ford will be sales for the company’s new mostly aluminum F-150 pickup truck.
Wednesday: The Federal Reserve’s Open Market Committee will probably do nothing on interest rates, but investors will be intently parsing any Fed comments for clues on what the U.S. central bank might do in December. Look for any change in the post-meeting statement on the Fed’s degree of worry about China now that it looks like that market has stabilized–for the moment, anyway.
Thursday: The U.S. Department of Commerce releases its preliminary estimate of third quarter GDP growth. Economists are looking for a year over year growth rate of just 1.9%, down from a 3.9% rate in the second quarter. The report will certainly move the odds on a December interest rate increase from the Federal Reserve. The odds for a December increase have moved up slightly recently on a decline in volatility in emerging markets.
Friday: The Bank of Japan meets: Will it stand pat on asset purchases and just reiterate recent comments from Governor Haruhiko Kuroda that the current program of quantitative easing is working (despite a lack of economic growth or inflation), or will the bank decide to increase its asset buying? Without some progress toward those two goals, the credibility of Abenomics will continue to erode. A promise last month from Prime Minister Shinzo Abe that the Japanese economy would be 20% larger by 2020 has resulted mostly in derisive laughter.