In a perfect world, the writing on the economic wall would be clear and concise. But as any student of the dismal science knows, we instead live in an alternative universe where trends are fuzzy, data is suspect, and stuff happens that degrades the value of otherwise reasonable analysis. Welcome, in short, to reality.
Reality, it seems to us, continues to be on display in all its exasperating shades of gray this year, and yesterday’s batch of economic releases continued in that vein. Let’s begin with the Conference Board’s leading economic indicators for July, which fell 0.1% last month. “The leading index has decreased in four of the last six months and the leading index has fallen below its most recent high reached in January,” the Conference Board explained in a press release. For the year through July, the leading indicator is down by 0.7%. “At the same time, real GDP grew at a 2.5 percent annual rate in the second quarter, following a 5.6 percent gain in the first quarter,” the press release observed. “The behavior of the leading index so far suggests that slow to moderate economic growth should continue in the second half of the year.”
That will cheer the Fed, which is currently staking its prestige on an economy that will moderate enough to take the edge off inflation but without creating a recession.
In fact, there’s an even split in trend among the ten factors that comprise the Conference Board’s leading indicator. By this metric, the economy is teetering, but which way it falls remains to be seen. Five of the factors rose last month, and five fell, allowing optimists and pessimists more than a little fodder for battling over what it all means. Consider the positive contributors, starting with the largest gainer, followed by those in descending order of import:
1. average weekly manufacturing hours
2. vendor performance
3. stock prices
4. index of consumer expectations
5. manufacturers’ new orders for consumer goods and materials.
In contrast, the negative contributors to the leading index, beginning with the largest negative contributor:
1. building permits
2. average weekly initial claims for unemployment insurance
3. interest rate spread
4. manufacturers’ new orders for nondefense capital goods
5. and real money supply
Deciding if one trumps the other, or if one side cancels the impact from the other, is the debate du jour. But for those who see the potential for more than a mild slowdown, yesterday’s update on weekly claims for jobless benefits suggests that there may be more strength in the economy than the leading index suggests.
Seasonally adjusted initial claims for unemployment insurance totaled 312,000 for the week through August 12, the Labor Department reported. That’s down slightly from both the previous week and a year ago. In other words, jobless claims are holding steady these days, belying worries that the economy’s about to take a tumble. Granted, jobless claims are but one number, and one should be careful about reading too much into its predictive power. But if the leading indicator trend is correct, the associated slowdown will begin revealing itself in jobless claims. So far, however, there’s scant evidence.
In fact, some contrarian thinking types continue to predict that there’s more inflation in the pipeline than some expect. One analyst who embraces this line of thinking says Mr. Market is destined for disappointment. David Gitlitz, chief economist at TrendMacrolytics, advised in a note to clients on Wednesday that growth is stronger than the consensus believes. “Financial markets, especially fixed income, have taken wing on the idea that growth is slowing enough and inflation appears tame enough to keep the Fed out of the picture,” he wrote. The markets, he continued,
want to believe that the Fed’s Phillips Curve/output-gap paradigm, in which inflation is a function of economic growth, will prevail — and with the pace of expansion apparently cooling, the Fed will have no reason to return to action. In the fullness of time, this is likely to go down as a serious misjudgment. As an inflation forecasting tool, the Phillips Curve has gotten it wrong time after time, while the market price model we use has repeatedly proven its validity. Besides, while the markets are counting on an economic slowing to continue providing the Fed with the cushion it needs to stay sidelined, from our perspective the growth outlook appears strong. At some point in the not too distant future, the Fed will unavoidably be forced to take more action to raise rates than either it or the markets are now anticipating.
In fact, we know that the economy’s pace isn’t what it used to be. The rate of expansion in GDP has declined, and there’s a widely publicized downshift in the residential real estate market. But the jury’s still out on the extent and duration of the slowdown. That is, unless you’re a central bank.
For the moment, the Federal Reserve expects that the downshift in the economy has legs, a reading on the future that increasingly extends to those in the world of bond trading. At one point yesterday, the yield on the benchmark 10-year Treasury dipped to 4.84%–the lowest since April 5.
The stock market too is becoming emboldened by the prospect of lower interest rates, as forecast by the renewed bullishness in the bond market. Just as the 10-year’s yield has made a clear downside breakout, the S&P 500 has done the same on the upside in recent sessions following the Fed’s decision last week to put rate hikes on hold. The S&P touched the 1300 mark yesterday for the first time since May. As a result, the S&P 500 is up 5.2% on the year through yesterday.
The renewed fondness for embracing risk is even popping up in emerging market equities. The dramatic selloff of the spring is currently in the process of being reversed. The MSCI Emerging Markets Index, measured in dollars, is up more than 10% for the past four weeks, according to Morningstar.com.
Ours is a time of questions about the path of least resistance for the economy, but for those charged with trading bonds and equities the dismal science moves too slowly. In the age of immediate gratification, the morrow must be dissected in definitive terms in the here and now, leading to definitive conclusions as to what comes next. Back in the real world, however, there’s more than a little confusion, but no trader worth his bonus is going to let that get in the way of his day job.