Do You Hear a Bell Ringing?

The sun shines brightest across the North American continent as we enter summer’s dog days.  Cold sweet lemonade is the refreshment of choice at ballparks and swimming holes alike.  Many people drink it after cutting the grass, or whenever else a respite from the heat and some thirst quenching satisfaction is needed.


Regardless of whether companies were able to “beat estimates” (which as often happens, were revised lower just before the reporting season started), their actual Q2 results didn’t look very encouraging so far. The manufacturing sector in particular looks a bit frayed around the edges as the saying goes. [PT]


The economy, after 10 years of growth, appears to be heading for a respite too.  Second quarter earnings, currently being reported by S&P 500 companies, have been a mixed bag thus far.  But in sectors that actually make stuff, like materials and industrials, earnings are suffering double digit declines.

From a practical standpoint, earnings are declining in these sectors because manufacturing is contracting.  For example, this week it was reported that the Chicago Purchasing Mangers’ Index (PMI) collapsed in July to 44.4.  That is the second weakest Chicago PMI reading since the Great Financial Crisis.

For context, a Chicago PMI reading below 50 indicates a contraction of the manufacturing sector in the Chicago region.  So far this year, the Chicago PMI has been down five out of seven months.  On top of that, weaker demand and production pushed the employment indicator into contraction for the first time since October 2017.


Chicago PMI – based on this indicator it looks as though the economy either has already entered a recession or is very close to doing so. Occasionally dips in the Chicago PMI do not presage a recession – as for example in late 2015/ early 2016. It remains to be seen if the signal is more meaningful this time, but it definitely constitutes a warning sign. [PT]


Unfortunately, the weakness in manufacturing extends beyond the Chicago region.  On Thursday it was reported that the U.S. Manufacturing PMI dropped in July to its lowest level since September 2009.  Employment also fell for the first time since June 2013.  What is going on?


US manufacturing PMI by Markit and the ISM manufacturing survey. These still indicate expansion, but are on the cusp of moving into contraction territory. Note: in terms of gross output, manufacturing remains the largest sector of the economy. [PT]


Economic Lemons

One place to look for edification is the auto industry.  Namely, car dealers are reporting fewer buyers. They are in turn ordering fewer vehicles from manufacturers. The dealers don’t have room for the cars they have.  Automakers, parts manufacturers and dealers directly employ more than two million people.  As demand for cars declines, the jobs associated with the auto industry also decline.

Having too many cars with too few buyers is something an economist would call a supply glut.  Of course, the easiest way to clear excess supply is to reduce prices.  This may work up to a point.  But if prices must be reduced beyond the cost of labor and materials inputs, there is a problem.

Making lemonade from these economic lemons is generally impossible.  Still, that doesn’t mean companies don’t try by taking on greater and greater levels of debt.  And the big banks, which are backstopped by the Fed, continue extending credit to keep the sham going.

U.S. non-financial corporate debt is about $10 trillion, or roughly 48 percent of gross domestic product (GDP).  That is up about 52 percent from its last peak in the third quarter of 2008, when corporate debt was about $6.6 trillion, roughly 44 percent of 2008 GDP.  In short, corporate debt is at record levels and is rising much faster than economic output.


US non-financial corporate debt is approaching USD 10 trillion. The corporate sector is not exactly prepared for an economic downturn.  [PT]


At this point in the business cycle, corporations have loaded themselves up with so much debt that they are extremely fragile.  Should the economy slow ever so slightly, it will be game over for countless over-leveraged companies. Defaults will pile up like old furniture and tires along the dry LA River bed.


Do You Hear a Bell Ringing?

But while Main Street has been cooling off, Wall Street has been running hot.  Promises of more cheap credit from the Fed have propelled stocks to record highs. Year-to-date, stocks, as measured by the S&P 500, are up over 17 percent.

On Wednesday, however, some uncertainty was added to the market. At the conclusion of the July Federal Open Market Committee (FOMC) meeting, Fed Chair Powell cut the federal funds rate 25 basis points.  But instead of telegraphing that additional rate cuts would follow like Wall Street expected, Powell said it was merely a mid-cycle adjustment.  In other words, he’s winging it.


S&P 500 Index, daily: a minor disturbance in the farce. This was the first time since 1987 that the index actually decline on the very day the first rate cut was announced. [PT]


Will the Fed cut rates further this year?  Will they hold?  These were the questions Wall Street was asking on Wednesday afternoon as the S&P 500 closed down 36 points.

Yesterday, after sleeping on the Fed’s ambivalence, traders showed up to work with focus and intent.  They bought the dip with confidence.  And everything was great until about mid-day.  The S&P 500 was up 33 points – and then something unexpected happened.

President Trump, via Twitter, dropped a turd in a crowded swimming pool:


“…the U.S. will start, on September 1st, putting a small additional tariff of 10% on the remaining 300 billion dollars of goods and products coming from China into our country.  This does not include the 250 billion dollars already tariffed at 25%.”


The market gets whacked by the God Emperor… [PT]


Following Trump’s tweet, Wall Street freaked out.  The S&P 500 dropped 68 points, ending the day at 2,953.

No one rings a bell at the top of the market,” says the old Wall Street adage. Make of this week’s manifestations what you will. We hear a bell ringing. Do you?


Charts by: Factset, Doug Short/Advidsorperspectives, St. Louis Fed


Chart and image captions by PT


MN Gordon is President and Founder of Direct Expressions LLC, an independent publishing company. He is the Editorial Director and Publisher of the Economic Prism – an E-Newsletter that tries to bring clarity to the muddy waters of economic policy and discusses interesting investment opportunities.




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