Tuesday, April 3, 2012

The recent slowdown in capex is not a reason to worry

New orders for capital goods (a good proxy for business investment) have been flat for the past six months. Does this portend an imminent recession? It might, but I think this is a fairly isolated event—I don't see any other signs of a looming recession, such as 1) an inverted yield curve, 2) very high real interest rates, 3) a significant widening of swap or credit spreads, or 4) a significant increase in first-time unemployment claims. In fact, all those classic recession indicators are behaving just the opposite, suggesting that a recession is nowhere in sight. I note further that, despite the slump in the past six months, capital goods orders are still up a strong 9.2% in the past year.

Capital goods orders are a subset of the much larger Factory Orders series, shown in the above chart. Here we see that orders are also up 9.2% in the past year, as well as being up at an 8% annualized rate in the past six months. No slump here, and these growth rates are very strong in an historical context.

One likely explanation for the recent slowdown/slump in capex was the expiration at the end of last year of business tax incentives such as immediate expensing of some capital goods: this had the effect of accelerating orders into last year and thus "borrowing" them from this year. If this is correct, then we should see capital goods orders resume their upward trend by summer.


Junkyard_hawg1985 said...

I think the biggest concern at present for the stock market and economy is a drop in corporate profits. Total ttm earnings for the Dow 30 fell from $122.27 in the 3Q11 to $118.13 in 4Q11. I expect earnings to fall again in 1Q12. A recession is typically preceded by a drop in corporate earnings. The big question is whether the earnings drop is temporary or the start of a trend.

Benjamin Cole said...

Excellent commentary, but I am worried about this sentence fragment:

"all those classic recession indicators are behaving just the opposite"

Yes, the word "classic."

Japan has had microscopic interest rates for two decades, and yet is mired in a perma-recession. Since they have been just bumbling along, I wonder if they have had spikes in unemployment---they have had a long-term moderate increase in unemployment. A nation were unemployment was once unheard of now has about 4.5 percent unemployment. Some Japanese cities even have homeless communities, a new apparition also. The yen is very strong.

The "classic" signals may not apply in the USA anymore, if we are imitating Japan.

Interest rates may even go lower, were we to sink into another recession. If we go into 1 percent a year growth mode, as in Japan, we may not see spikes in unemployment, as large fractions of the work force will retire, move in with parents, or double up with friends. We may be shrinking our economy permanently, relative to potential. How wonderful, but we will beat inflation.

If the Fed decides to fight global commodity inflation with tight money (as they did in 2008), we will certainly spiral down into another recession.

Like Scott Grannis, I have a supply-sider in me---tax rates on productive behavior should be as low as possible, and we should always err on the light side in regulations.

But Japan has been "reforming" its retailing, work place and banking systems for decades, and it still is the weak man of Western economies, while money-printing China has boomed.

There is a reason Milton Friedman obsessed about monetary policy---and advised Japan to print a lot more money. He actually advised Japan to court growth and inflation through the heavy printing of money and buying of government bonds. Friedman expressed no moral qualms about "debasing" the currency and none whatsoever about monetizing Japan's debt.

One thing about Friedman: He is almost always right.

BTW, John Taylor just gave a good review to a new book by a guy named Hetzel, who advises Market Monetarism. Taylor says to read the book.

Squire said...

I am confident the Fed will keep inflation at a sufficient 2+%. Much higher and they risk a speed up of the USD loosing its world reserve status. Then printing money becomes a problem the bond market will deal with.

Steady but sure is better than boom and bust. No risk of boom? Good, leave it that way.

Junkyard_hawg1985 said...

Before the increase in unemployment claims or other recession indicators, the first step is usually a drop in corporate profits. The ttm profits for the dow 30 stocks was $122.27 (EPS of all 30 companies) in 3Q11 and it fell to $118.13 in 4Q11. This was the first drop since 2009. The average quarterly Y-o-Y growth in revenues for the Dow 30 fell from 12.5% in 3Q11 to 6.3% in the 4th quarter. My guess is that 1Q12 will be worse on both fronts. The cut back in capital spending may be the first sign that companies are starting to cut back. I think 2Q12 is the critical quarter to see if it is a temporary dip or the start of a trend.

Public Library said...

How do you have an inverted yield curve in this monetary environment? Dump that indicator...

Scott Grannis said...

Re: corporate profits. I note that after tax corporate profits as calculated by BEA (NIPA) started declining in 2007, 4 years before the 2001 mini-recession. Reported (GAAP) profits tend to lag NIPA profits. Neither measure as yet shows any decline.

Junkyard_hawg1985 said...


Riht now the U.S. economy is doing significantly better than the rest of the world. As such, the corporate earning for the companies with the most overseas exposure (Dow 30) are taking a bigger hit than the rest. I hope this does not spread to the rest of the U.S. economy.

You point about the NIPA profits to start dropping well below the 2001 recession is valid. Others did not have such a lag.

Earnings peak in 3Q06, recession began Dec 2007.

3Q81 peak for 1982 recession.