The stock market is a discounting mechanism, where the buying and selling actions of numerous investors provides a sense for their aggregate macro outlook. The ongoing panicky market sell-off appears to be telling a grim story.
The sell-off implies, in my view, that investors are expecting a far worse outlook for the U.S. economy than a mere downward adjustment from earlier, more optimistic expectations. This kind of stock market action, when coupled with the behavior of Treasury yields despite the S&P downgrade, is pointing towards a recession in the coming months.
I don't believe a recessionary outlook for the U.S. economy is warranted by recent data. Granted, economic reports are clearly showing that what appeared to be a temporary soft patch in the first half of the year has carried into the back half as well. This means that earlier expectations for the resumption of robust growth in the third quarter and beyond were off base and need to come down. And we are seeing those growth estimates come down in recent days.
It is one thing for the economy to be operating at less than its optimal speed, and an altogether different one for it to be heading into negative territory. The odds of a recession have no doubt increased. But there is momentum in recent data indicating that such an outcome will be avoided.
Plenty of Room for Economic Optimism
We all know the grim economic news of recent days, starting with the weak second-quarter GDP report and sharp negative revisions to the growth numbers for prior quarters. The GDP report and revisions showed that the U.S. economy entered the second half with a lot less momentum than was earlier thought. The ISM reports for July confirmed that the so-called temporary soft patch from the first half has crept into the second half as well. But this hardly means that we are moving into recessionary territory.
Here are the four reasons why I feel more sanguine about the economic outlook than what the stock market has been telling us lately:
A – Improving Consumer Spending Outlook: A key restraining element in the sub-par second quarter GDP report was the effectively flat consumer spending reading. Consumer spending, which accounts for more than two-thirds of the economy, increased at a mere 0.1% in the second quarter, after a 2.1% pace in the first quarter.
There were clearly one-off factors that held consumer spending back last quarter and have started to reverse in the current quarter. Motor vehicle-related spending dropped 0.91% in the second quarter from positive 0.53% growth in the first quarter and consistent positive growth in the preceding four quarters. Weak auto sales were solely a function of the Japan-related supply chain disruptions, which has started to reverse in July. The 700 thousand jump in light vehicle sales in July shows that consumer spending on motor vehicles should track what we saw in the earlier quarters, adding to third quarter growth.
B – Improving Labor Market Picture: On the subject of consumer spending, Friday's positive non-farm payroll report for July also needs to be highlighted. Not only were more than 150 thousand private-sector jobs created in July, but the tallies for June and May were revised upwards by a combined 57 thousand. We could see further evidence of Japan-related weakness in payrolls as manufacturing jobs increased nicely from the June/May levels. Average hourly earnings also increased after remaining flat over the preceding months, which coupled with the pullback in fuel prices should help consumer spending power on the margin.
When we look at the July non-farm payroll report in combination with other labor market readings (such as the ADP report), the weekly jobless claims data and the employment components of the ISM reports, it becomes clear that labor market gains may not be satisfactory, but they are not deteriorating either.
C – Momentum in Private Capital Spending: Another source of positive momentum is private capital investments, where trends look favorable in the third quarter. Investments in equipment and software increased at a 5.7% rate in the second quarter, down from the first quarter's 8.7% pace.
The internals of last week's broadly inline June 'factory orders' report were encouraging. 'Core' capital goods orders (ex-defense & aircraft) were revised upwards for May and were up in June, implying more favorable momentum in July than previously thought. We do not see this type of capital investments in an economy that is heading towards a recession.
D – Solid Corporate Balance Sheets: Driving the positive momentum in capital expenditures is the extremely solid profitability and finances of corporate America. As I discussed here last week, the corporate earnings picture remains quite favorable even if estimates are prone to some downward revisions. And the amount of cash on corporate balance sheets is at multi-decade highs at present.
Growing corporate outlays on capital spending and payrolls has the potential to put the economic recovery on a sustainable trajectory that does not need fiscal and monetary stimulus. The grid-lock in Washington that we saw during the debt ceiling debate may be a blessing in disguise by forcing the protagonists to leave the economy alone.
Putting It All Together
The extent of the pullback reflects a recessionary scenario for the U.S. economy, which is not borne by data. The growth prospects for the U.S. economy in the second half of the year have come down from earlier expectations of above 3% to somewhere under 2%. And as I explained above, you don't need to make aggressive assumptions to reach the 2% growth outlook.
Granted, recessionary risks have increased. If I had to describe the odds of a recession over the next 6-12 months, I would put it around 20%. Exogenous shocks in the shape of the European debt situation or deterioration in U.S. consumer spending or the labor market would increase those odds. But there is nothing in current data that would justify such a scenario.
This outlook has significant investment implications, particularly following the indiscriminate market sell-off. It will not take much for the market to come to its senses after making a dispassionate analysis along the lines I suggest above. I think that we are close to the bottom, if we haven't already reached there, with the tide turning in short order. I am not looking for a roaring rally in the opposite direction. But plenty of quality stocks have received unnecessary beatings in the last few days and those names will snap right back towards their previous levels.
That's why I am not advocating talking shelter in defensive sectors like healthcare, utilities, and consumer staples. You have your pick of leaders from all kinds of industries that are selling at massive discounts to intrinsic values. Let’s buy these choice names while everyone else is running for cover and not paying attention.
Best Regards,
Sheraz Mian
Director of Research
عاد الترجمة عليكم ، سحورا هنيئا ان شاء الله