The only thing worse than crumbling stock prices is a market slide that’s accompanied by a contracting economy. The US has witnessed the former recently, but it’s not obvious that the macro trend is fatally wounded. The outlook for growth remains moderate for the world’s largest economy, which is to say that the trend is more or less unchanged from recent history. As a result, the forecast that the US is slipping into the business-cycle ditch sounds like an emotional reaction to recent market volatility rather than an objective review of the published data to date.
The latest installment of optimism for thinking that the US will continue to grow: yesterday’s July report on durable goods orders, which posted a solid gain for the second month in a row. Business investment—non-defense orders less aircraft—also increased at a healthy pace in the past two months. That’s the first time we’ve seen back-to-back monthly increases for both indicators—at the same time—in over two years.
Durable goods orders are volatile, of course, and so this data alone may not be reliable for assessing the big-picture trend. But recent numbers from other corners of the economy also look encouraging, including the latest run of housing data for July, which includes upbeat numbers on residential construction and sales.
Not surprisingly, the broad trend through last month betrays few signs of a struggling US economy, based on the Chicago Fed National Activity Index and The Capital Spectator’s proprietary business-cycle indexes.
It’s still early for assessing how August’s macro profile compares, but there are upbeat clues via Markit’s survey numbers for the manufacturing and services sectors. Although manufacturing activity has weakened lately, the dominant services sector continues to post a solid, steady rate of growth. The overall trend doesn’t look all that different from the modest expansion of recent history and so for the moment it’s hard to make a case that the economy is stumbling.
Yesterday’s update from the Atlanta Fed on the outlook for US GDP growth in the third quarter still anticipates sluggish growth, but at least it’s improving, if only slightly. The Aug. 26 revision ticked up to a projected 1.4% gain (seasonally adjusted annual rate).
The next major hurdle for re-evaluating the US macro outlook arrives with the August employment report, scheduled for release next week (September 4). But here, too, the signals still look positive. Initial jobless claims—a leading indicator for payrolls—remain close to multi-decade lows. In turn, the low level of new filings for unemployment benefits through mid-August implies that we’ll see another decent number in next week’s update on nonfarm payrolls for this month.
China’s a bit of a wild card, of course. Although some commentators are looking for a full-blown meltdown that will drag down the global economy, a more reasoned view is that China’s transitioning (maturing) to a period of slower growth. That’s hardly a shock—after years of high growth, it’s inevitable that China’s expansion would slow. Maintaining a 7% growth rate for the world’s second-largest economy is becoming increasingly difficult, but that’s a normal process after a long run of development. In short, a moderately lesser pace of growth for China is certainly within the realm of possibility.
Still, coming to terms with this downshift in growth has rattled investors, who’ve become accustomed to sizzling gains in China’s economy in recent years. The country’s stock market in particular has been wildly optimistic about the prospects for ongoing growth—a speculative binge that’s recently been deflated.
Speaking of stock markets, it’s dangerous to view equities as a flawless predictor of economic activity. Yes, the trend in stocks is an important input for assessing the macro trend and no business-cycle analysis can afford to overlook this data. But history reminds that relying on the market alone for evaluating the big picture—particularly for the US—is asking for trouble.
Granted, the latest swoon in US equities could be an early warning sign for the business cycle. But it may turn out to be nothing more than a healthy correction. Indeed, if the US economy holds on to its moderate growth rate of late, which remains my working assumption at the moment, the latest market dive looks like a buying opportunity rather than the start of a bear market and economic recession. In short, the stock market’s stumbles aren’t always linked to deep macro trouble.
Deciding how the current environment ranks is a work in progress, of course. But for now, the incoming economic figures offer support for cautious optimism. That could change, of course, which is a reminder that the next several weeks of macro updates may be crucial.
As for investment strategy, the case for reducing risk exposures has been compelling for months. Back in April of this year, for instance, I noted that the spread in the trailing one-year returns in ETF proxies for the major asset classes had surged to relatively high levels—a sign that it was a good time to rebalance portfolios. Earlier this month, I observed that the negative momentum weighing on most markets around the world was still in force and that “I’d be inclined to wait for a return of positive momentum before trying to catch a falling knife.” Soon after, all hell broke loose.
Negative momentum still dominates across the major asset classes and so the case for a major risk-on play remains premature. As for US stocks, the events of recent days have elevated several risk metrics for the market outlook, although it’s not yet a full-blown sell signal. The next several days, depending on what happens, could be decisive, however.
Meantime, the US macro outlook still looks decent. If that gives way, however, we’re looking at a considerably darker future. I don’t expect that to happen, but one can’t rule it out at this point. If and when I change my view, rest assured that it’ll be based on the data.