Business Conditions Tighten After Hike & After Cut

Jobless Claims Say To Buy Stocks

Jobless claims have had a high correlation with stocks for a long time. Even though states have made it harder to file for claims, they still have stayed correlated with the market. It’s possible that claims aren’t accurate in their portrayal of this being the tightest labor market in history (adjusting for population), but still tell us where stocks are headed. Regardless of how much harder it has become to file; claims will still increase in the next recession. It’s just possible that they don’t increase as high as previous cycles. Since I’m not expecting the next recession to be as bad as 2007-09, it’s even more likely that they peak at a lower level.

Jobless claims are still telling investors to buy stocks even though the yield curve states there is elevated recession risk. If the economy was in a recession, claims would be much higher. In the week of August 3rd, claims fell from 217,000 to 209,000 which beat estimates for 215,000 (obviously lower numbers are better).

The 4 week moving average increased slightly from 212,000 to 212,250 as you can see in the chart above. We aren’t even close to near the 4 week moving average being an issue. It wasn’t an issue when the 4 week average got above 225,000 in February. The best way to determine if a spike is a recession warning is to see if the spike sustains itself. Claims can spike temporarily without it meaning anything. Continuing claims in the prior week fell 15,000 to 1.684 million. The 4 week moving average fell 11,000 to 1.687 million.

Financial Conditions Tighten Briefly

The financial conditions index is correlated with the stock market, so it’s not a surprise conditions tightened in August when the correction occurred. As you can see from the chart below, conditions tightened very quickly. They didn’t get as tight as they did in December when the stock market fell about 20%. That was a relatively severe recession scare. Sometimes the market barely falls that much when an actual recession happens. It’s interesting how financial conditions tightened when the Fed raised rates in December and also tightened in August when they cut rates. The Fed is damned if it does and damned if it doesn’t. Of course, the elephant in the room is the trade war which caused investors to be unnerved in both periods.

I am showing this chart because the Fed was criticized for cutting rates in August when financial conditions were easy as it was called a preemptive move. It’s amazing to see the criticism quickly reverse when stocks fell after the Fed meeting. After Trump announced his latest tariff, critics came out saying the Fed should have cut rates 50 basis points. The tide turned after a simple ~7% correction.

Based on the economic data, I didn’t see the need for a cut because I didn’t see a recession coming. However, since inflation is low and the dollar would spike without a cut, it was perfectly rational for the Fed to cut rates. The Fed will only go through with a couple more cuts if it sees a recession. The Fed has no problem cutting rates even if it doesn’t see a recession because it calls this action a midcycle adjustment. It will very interesting to see at one point this becomes a cut cycle. If I had to put a number on it, I’d say 3 cuts make this a new cut cycle since interest rates are already so low. If the Fed cuts 25 basis points again in September, that threshold will be hit in October or December.

Sectors Diverge

Domestically the relative performance of the manufacturing sector versus the services sector depends on if you follow the Markit or ISM PMIs. Markit shows services improved in July and manufacturing fell, while the ISM reports show both fell. I’m interested to see how the tariffs affect the non-manufacturing ISM because the next tranche of tariffs starting in September is mostly capital and consumer goods.

The fact that the consumer is about to be impacted by this round of tariffs more than any other provides another reason why I think President Trump will give in soon. These tariffs have the greatest potential to hurt his popularity. If I was in his position, I wouldn’t have implemented this round of tariffs if I thought there was no chance of a détente/agreement. If I though an agreement would be made in the next few months if I just pushed a little further, I would have gone for this tranche of tariffs. It’s all or nothing for him since a deal will help his popularity and the economy and increased tensions could catalyze a recession.  

Looking at the global economy, it appears the service sector is outperforming. As you can see in the chart below, about 70% manufacturing PMIs are below 50 and 0% of services PMIs are below 50 PMI. This is Markit data. The trade war has had a much bigger impact on the manufacturing sector. In July, the JP Morgan global manufacturing PMI fell from 49.4 to 49.3 and the service sector PMI rose from 51.9 to 52.5. The one big negative in the service sector report was that the future activity index fell from 60.1 to 58.9.

Conclusion

Anytime there is volatility, financial conditions tighten. If conditions are only tight for a few weeks, it won’t have a major impact on the economy. Despite recession worries catalyzing a relatively modest correction in August, jobless claims are still near their cycle low. I won’t worry until claims move significantly higher and stay there for a couple months. Ignore the noise in the data caused by onetime events. The U.S. service sector is likely outperforming manufacturing, but it might start to lose strength when the new tariffs are put through in September. About 70% of global economies have manufacturing PMIs below 50, (which is contraction) while none have a service sector PMI below 50.

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