Thursday, October 1, 2015
Markets are still very worried that the U.S. economy is going to succumb to all the nasty things going on in the world: a pronounced slowdown in the Chinese economy, the struggles of commodity-dependent economies (e.g., Brazil, Australia, Canada), the sudden reversal of fortune of the world's oil producers, and the recent heightened U.S.-Russian conflict in the Middle East. Is the world spinning out of control? Can the U.S. remain a bastion of strength in a weakened world? These are the questions that investors are struggling with as they decide whether to de-risk and seek out the safety of cash, even if that means giving up significant yield.
As the chart above suggests, fleeing corporate debt, emerging market debt, and equities implies giving up yields of 5-8% at a time when cash is yielding almost nothing.
The decision is not obvious, nor is it easy. Although it is unusual for the global economic tail to wag the huge U.S. economy dog, it's not impossible. What would be the consequences for the world if Russia effectively controls the better part of the Middle East? There's lots of uncharted water out there. Would a tiny hike in U.S. interest rates push too many fragile economies over the edge?
While pondering these uncertainties, it's important to remember that the vital signs of the U.S. economy are still reasonably healthy.
Weekly unemployment claims are within an inch of a multi-decade low. If the U.S. economy were fraying on the margin, claims would be rising, not falling.
Announced corporate layoffs have ticked up a bit in recent months, but the big rise was due to one-time troop reductions. On balance, layoff activity remains relatively muted, confirming the message of weekly claims. It's worth noting as well that only 1.87 million people in the U.S. currently are receiving jobless claims. That's a huge drop from the 2010 high of 11.65 million, and it is the lowest in almost 15 years.
This morning's ISM announcement was about as expected, but as the chart above shows, activity in the manufacturing sector has been slowing down of late. Nevertheless, the index is still well above levels that would signal an emerging recession in the overall economy.
Not surprisingly, weakness in the rest of the world has shown up in a softening of export orders to U.S. manufacturers.
As the charts above show, manufacturing activity in the Eurozone continues to expand, albeit slowly. The low level of Eurozone swap spreads reflects generally healthy financial conditions and thus points to continued growth.
Manufacturing activity may be on the soft side, but construction spending is rising at strong, double-digit growth rates. Residential construction activity is still far below the levels of a decade ago, and thus has lots of upside potential left.
Credit spreads are clearly elevated, but their message—that a weakened economy is increasing default risk—is still not yet at crisis levels. Importantly, swap spreads are quite low, which suggests that the economy still sits on strong financial bedrock. Fears are high, but systemic risks are low. Markets are very liquid, and that is a necessary if not sufficient condition for surviving the current turmoil.
Car sales have doubled in the past six years, and September sales exceeded expectations. On a 3-mo. moving average basis (to filter out the monthly noise), sales are up over 6% in the past year. As the chart above shows, sales have rarely been this strong. But that's not surprising, since sales fell so much for so long that there has to be some catch-up. The U.S. auto fleet has aged meaningfully over the past six years, and it will most likely take several years of above-average growth to get back to what we previously considered "normal." So there's every reason to expect sales to continue to increase for at least the next year or so.
Posted by Scott Grannis at 12:05 PM