Monday, August 2, 2010

ISM indices say the "new normal" economy is a no-show


Just came back from touring fabulous Cape Town. Really a gorgeous city that reminds me of the best of San Francisco, San Diego, and even Hong Kong. I'll post some photos in a bit. Anyway, I am happy to see that the market is up, and it would appear that once again it's because the news on the economy has proven stronger than expected. The ISM manufacturing index (above) was stronger than expected, and as my chart suggests, this is fully consistent with the 3-4% economic growth rate (if not more) that I've been expecting to see for the past year. It's a bit weaker than the fabulously strong levels that were showing up recently, but it is not supporting the popular "new normal" economy theory, in which growth registers a feeble 2-3%.


Most encouraging was the employment index (above) which is still at very strong levels that have been seen only rarely in the past several decades. This is very good news, since the weakest part of the recovery so far has been jobs and business investment, and the ISM index suggests that the manufacturing sector has shrugged off this malaise quite nicely.

My thesis is still in place: this economy is growing at a 3-4% pace, which is not very impressive given the extent of the recent recession, but it is stronger than the market has been expecting, and that is enough to drive equity prices higher and corporate spreads lower. It is also serving to weaken the dollar, since a moderately growing economy reduces the need for the world to seek shelter in the dollar for fear of a double-dip recession or worse.

Since 10-yr Treasury yields are still hovering just under 3% (a level that is only consistent with a market that is fundamentally bearish on the economy and very concerned about deflationary pressures that presumably arise from sustained economic weakness), I believe I am still correct in saying that the equity market is cheap and the Treasury market is very expensive.

6 comments:

Jake said...

The economy is estimated to have grown by 2.4% in Q2 by the BEA. Do you think this is wrong?

Scott Grannis said...

Jake: keep in mind that the 2.4% growth for Q2 is an estimate that will be revised several times at least. Plus, quarterly GDP figures can be volatile, and every up and down does not signify a change in trend. You just can't put a lot of weight on one GDP number. You need to look at a whole lot of things to get a feel for where the economy is headed. I still see lots of signs of growth that are consistent with a 3-4% trend. One slightly weak number doesn't change my outlook.

Jake said...

agreed, but i was personally surprised that the past 2 years were revised significantly down (in aggregate), thus the recession was actually about 1% below (in real terms) previously thought levels.

shorter term my concern is the composition of GDP over the past 3-4 quarters. a huge rebound in inventory rebuild (a good sign, but won't drive future growth), slowing end-user demand, and a large decrease in exports (perhaps from the strong dollar, which is weakening).

the jump in business investment was a good sign, which hopefully we can build on.

Benjamin said...

Lately, the economy seems to be losing steam..a lot of downlines, instead of uplines....

Fed action needed.

Bill said...

Yes, but why does GDP come in at 5% and 3.7% when IMS is saying the growth will be much higher? Does that suggest that ISM's projections for growth is too high?

Scott Grannis said...

Bill: there are no perfect fits between two sets of data. And it is quite possible that manufacturing can be doing a lot better than the service sector, so that strong ISM readings are not translating into stronger GDP readings. Whatever the case, I take the ISM indices as a very good sign that the economy is growing, and in the current climate of negativism that is very good news.