Outlook for economic growth: the slowdown continues


By Chris Yates

As I have explained in several recent articles, key economic data continues to suggest that a cyclical downturn in the business cycle is upon us and should continue to persist over the next several months. In addition, a continued slowdown in growth may precipitate a deceleration in the rate of change of inflation, indicating a transition from a macroeconomic regime of stagflation to one of outright disinflation, where inflation and growth slow together. As such, investors would do well to position their portfolios defensively and reduce risks, especially with the notion of a probable Federal Reserve monetary tightening on the horizon.

Leading indicators: credit creation

Starting with what is perhaps the best indicator of the growth potential of the real economy, as opposed to the financial economy alone, the G3 credit impulse is now firmly in negative territory after peaking in the later stages. from 2020.

Source: Nordea

Credit impulse is a measure of the rate of change in new credit creation as a percentage of GDP, with measure G3 above incorporating this data from the United States, China and Europe. Unlike pure monetary measures such as M2 money supply, credit creation measures the rate of change in credit creation in the real economy, via commercial bank lending and budget deficit spending, and is therefore a good best tool to predict the growth of the real economy. The credit boost is indeed a leading indicator for roughly all, typically around 10 to 12 months.

Chinese bond yields, which are themselves a great leading indicator of the global economic cycle, confirm the credit boost message. China remains the world’s largest manufacturer and is responsible for much of the global economic cycle. Like their credit creation, Chinese yields have been trending down since their short-term cyclical peak in December 2020.

Source: Economics of Commerce

Leading indicators: Construction

As for the manufacturing sector, building permits for new homes have been decelerating at an alarming rate of change from year to year at an alarming rate since April.

A reduction in building permits indicates slower growth in the housing and construction sector, as building permits precede the construction of new homes and indicate a decrease in demand.

Leading indicators: manufacturing

The manufacturing sector also confirms the slowdown in growth. The US Census Bureau’s manufacturing inventory-to-sales ratio continues to trend upward, reaching an almost positive year-over-year rate of change.

When sales increase faster than inventory and the ratio decreases, then more inventory must be produced, putting upward pressure on prices, as well as an increased need for workers and hours worked. When inventory grows faster than sales, the reverse happens.

We can extrapolate further by focusing on Census Bureau data on new manufacturing orders, which continue to slow after peaking in April of this year. As new orders are very responsive to demand, a deceleration in data clearly indicates slowing growth in the manufacturing sector.

Again, we can extend this to see both the growth rate of new orders for durable goods and capital goods peaked between March and April 2021 and is slowing down. Both measures provide a good head start on the short-term direction of the economy.

Among the US ISM Manufacturing Index, supplier delivery times is another leading indicator with important consequences, as this metric gives us a good reading of supply chain disruptions in the manufacturing sector. As with the manufacturing data presented above, supplier delivery times according to ISM Manufacturing Index participants have been trending down since May.

US ISM Manufacturing Supplier Shipments Index

Source: YCharts

Unsurprisingly, as manufacturing demand and delivery times begin to decline, we are also seeing the ISM Manufacturing Price Paid Index start to decline. As supply constraints ease and demand slows, it’s no surprise that the prices paid follow suit. As these ISM readings tend to move lower, this tells us that fewer manufacturing executives are facing supply constraints and price increases from the previous month.

ISM U.S. Manufacturing Prices Paid Index

Source: YCharts

Industrial raw materials also confirm this message. Although they remain high in nominal terms, the growth in the prices of industrial raw materials is slowing down markedly.

The same is true of employment in the manufacturing and construction sectors. Aggregate data for the two peaked in April on a year-over-year rate-of-change basis and have since slowed.

Leading indicators: consumer demand

From a consumer demand perspective, the University of Michigan Consumer Purchase Intention Survey for Vehicles, Homes and Housewares remains near its lowest levels in some time. The surge in inflation in recent months is clearly having an impact on consumer demand for goods. Clearly, demand is declining not only in the manufacturing and construction sectors, but also in households.

Source: Acheron Insights, University of Michigan

Other leading indicators

Turning now to several broader leading indicators of economic growth, the growth rate of the Economic Cycle Research Institute (ECRI) weekly leading indicator continues to decline after its April peak. As ERCI noted, this composite index is typically 2-3 quarters ahead of cyclical turning points in the economy.

Source: Institute for Research on the Economic Cycle (ECRI)

Source: Institute for Research on the Economic Cycle (ECRI)

The Citibank Economic Surprise Index remains firmly in negative territory. This index measures the level of economic data coming out better or worse than expected, and so, when in negative territory, it indicates that more economic data releases are disappointing on the downside rather than surprising on the upside.

And finally, SentimenTrader’s macro index pattern recently triggered a sell signal. This index combines 11 economic indicators to determine the current state of the US economy (with a focus on the housing market and the labor market), the indicators of which are; new home sales, housing starts, building permits, initial claims, continuing claims, heavy truck sales, yield curve, S&P 500 vs. 10-month moving average, ISM manufacturing PMI index, margin debt and securities year-on-year inflation.

Coincident indicators

The coincident economic indicators confirm the trends of the main economic indicators that I have detailed above. While not necessarily useful for predicting changes in the business cycle, they are important data points that define and confirm trends in economic growth.

The growth in total non-farm employment can be seen to confirm April’s cyclical growth peak.

The same goes for the personal consumption of the two goods. and services.

While we expected to see the growth rate of consumption of goods slow down, as the lockdown-induced spike in goods consumption was always going to be unsustainable once the economy started to reopen, a deceleration in consumption of goods coupled with the deceleration in the growth of consumption of services seems to confirm the message of a slowdown in the economic cycle.

Financial market performance

Turning now to financial markets, as I noted earlier, some of the sectors most sensitive to the stock market cycle in the stock market have largely confirmed the story of the growth cycle outlined above. The relative performance of the Retail, Transportation, Metals & Mining, Materials & Industrials sectors against the S&P 500 all peaked in the first half of 2021 and have underperformed ever since.