The US economy continues to show weakening conditions as new warning signs are flashing recession ahead. This is despite the best efforts of the FED and the US Government to ensure there is plenty of measures in place to continue to stimulate the economy.
Over the last few weeks we have received several economic announcements on the US economy, with a few positive or better than expected results. However the vast majority of announcements have been poor or woeful as the economic data continues to show further weakness within the economy.
US Q3 GDP – A Convenient Smokescreen
An Hour With Ben Graham
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I know what your thinking, hang on a minute on Friday we had a first look at US Q3 GDP and the result was positive and even beat expectations. This is correct GDP came in at 2.9% beating expectations of 2.5% and smashing last quarter’s result of 1.4%.
However I find the result convenient and timely considering there is an election in less than 2 weeks time. The second and third estimate for GDP could see considerable revisions lower after the election has ended.
The other interesting points about the GDP result was that a 1/3 of the GDP growth came from a one off exporting boost of Soybeans. This is not a normal occurrence for the US however due to shortages in other countries due to crop damage, there was a surge in demand for soybeans exports. The one off export surge contributed 0.61% of the GDP growth.
Another big factor for the surge in GDP was a large inventory buildup in the quarter contributing 1.17% of the GDP growth. The most likely reason for the surge in inventories is in anticipation of a big pickup in spending for Christmas. However as I’m about to show you below the US consumer is struggling to meet their living costs, as the consumer is no longer confident and struggling with price rises for everyday items.
In addition the majority of the job gains over the last 12 months have been in part time jobs and low paying services jobs like in restaurants and bars which typically bring in lower incomes. Therefore companies are going to find it difficult to clear all the inventory ordered in the Q3 for the coming quarter. This will lead itself to lower GDP result the following quarter as companies struggle to clear excess inventory over the holiday period.
Lastly GDP is measured after deducting inflation for the quarter. In the most recent quarter released last Friday the GDP price index / inflation was measured to be 1.4% compared to 2.3% last quarter. This means the Government is indicating that inflation has slowed considerably from the previous quarter. For everyday citizens in the US they know this doesn’t make much sense as rent, food, fuel, electricity, healthcare and education continues to jump higher making it harder for average American’s to pay for everyday items. If the GDP price index remained the same as the previous quarter at 2.3% the GDP would of been further reduced to reflect a more accurate measure of US economy.
Leading Indicator – Investment Swings To Contraction
Over the last 65 years you can see the steady decline in terms of investment as the US slowly began investing less into the economy with each economic cycle. More importantly each down turn in investment relative to GDP was a perfect leading indicator to a US recession, as corporate America cut back spending with each contraction within the economy.
The red marker’s together with the red vertical lines on the chart represent the start and ending of economic contractions (recessions) in US history since 1950.
Currently investment has again peaked within the new cycle and is now heading down indicating the US economy is about to head into a recession if the economy is not already in one unofficially.
FED Chart Predicts Recession 71% Of The TimeThis chart is one the FED monitors to determines the strength of the labor market. The vertical pink lines are previous recorded official recessions within the US since 1977. The circles are to illustrate each time the labor market conditions fall’s below 0%. Since 1977 five out of the seven times or 71% of cases the index has fallen below zero the economy has fallen into a recession. Currently this Labor market conditions index has fallen below zero.
Consecutive Quarters Of Declining Earnings
Here is another chart showing US corporate profits going back to around 1950. The vertical red lines represents each time the US has had a recession since the 50’s.
What you will notice is that each recession except one back in the late 80’s resulted in corporate profits declining for consecutive quarters. Or the fact corporate profits fell consecutively leading to a recession most of the time.
Presently the US has had 5 consecutive quarters of corporate profits falling. The current quarter profit season is still in progress with high odds that we will make 6 consecutive quarters of declining profits. If this occurs this will the most quarters of profits declining without a recession officially occurring.
No Revenue Growth = Business Cut Spending.Last Thursday the US released durable goods spending which represents capital expenditure by companies. The chart below is the capital goods orders that excludes defense and Aircraft spending. This chart is important as it’s a proxy for business spending in general and gives you an indication of the strength of corporate America.
If you look over to the right side of the chart below you can see that capital goods spending has basically been declining nearly every quarter since 2014. If the economy was strong companies would be investing in more capital goods to grow production and revenue. This would be from an increase in demand for the goods and services they provide. However the opposite is present as demand continues to fall leading to companies cutting back expenditure to counter weak demand.
The chart below coincides with the lack of capital spending for companies in the US. Because more companies are facing tougher conditions to grow their business falling to levels seen in 2014, companies have had to rely on cost cutting and stock buybacks to lift earnings per share (EPS) rather than on actual revenues increases.
With rates so low in the US at 0.25% it’s not a good indication that business conditions are declining.
Poor Christmas Sales Foretasted
Consumer confidence continues to fall with the latest results on last Friday showing confidence dropping again to levels last seen in 2014.
Like I mentioned above regarding the huge inventory build of companies for the lead up to Christmas. Companies will realize in the coming months that this was not a good idea, as the consumer does not feel confident with rising prices and lower spending power from their paychecks, leading to lower spending than the previous holiday season.
Bad Debts Spiking In 0% Environment.
This particular chart shows the delinquency rate on company loans made by banks since the late 80’s. The last 2 recessions the US had in 2001 and 2008, both show delinquency rates spiking before each recession occurred.
In the current business cycle delinquency rates / bad debts have spiked from below 1% to the current level of 1.6%. Keep in mind interest rates are currently at 0.25% having been at zero for about 6 years. Therefore rates are extremely low compared to previous business cycles yet companies are having trouble paying their loans.
The other troubling fact for the banks is that debt level for companies are much higher than the last recession. This is due to record low rates enticing companies to borrow to start or increase stock buybacks and increase dividends. So any fallout from an accelerated delinquencies within corporate lending, will have a much deeper negative impact to bank’s solvency than the 08 recession.
Leading Indicator Small Cap Index – Breaking Down
Small companies are traditionally a leading indicator of strength and weakness within an economy. When an economy is set to expand out of contraction you will notice that smaller companies tend to lead higher in price before large cap and blue chip companies do.
On Friday the Russell 2000 index which is the US small cap index broke a key support level on both a weekly and daily chart. Even though the S&P 500 is still within record highs, the small cap index has broke away from the larger index as it has ended its long term uptrend as well key support levels.
If you would like to check out my chart review of the Russell 2000 breaking down click on the following link: Russell 2000 review
Thanks for checking out my latest post.
By Guy Manno, Originally Published at Crush the Market