– March 6, 2020

AIER’s Leading Indicators Index remains close to neutral; coronavirus threatens outlook.

AIER’s Leading Indicators Index rose 4 points to a reading of 54 in February, up from 50 in January. The Roughly Coincident Indicators Index and the Lagging Indicators Index both fell, to 75 and 42, respectively (see chart). February is the tenth consecutive month within the 46 to 54 range for the Leading Indicators Index. The continuing modest performance of the Leading Indicators Index reflects the varied performance among the major sectors of the economy and overall slow pace of growth.

The risks from the coronavirus (COVID-19) are still unknown but appear to be growing. The outbreak has already had wide-ranging, mostly negative, effects. The effects on economic activity will almost certainly be significant enough to be reflected in economic statistics, likely beginning with monthly reports released in April and covering the month of March. High frequency statistics such as initial claims for unemployment insurance and same-store retail sales have not shown a significant impact as yet. Many public companies have announced significant impacts on operations, and lowered sales and earnings expectations accordingly. Financial markets have reacted sharply, reflecting the role fear and emotions play in day-to-day market prices.

The emergency rate cut by the Federal Reserve acknowledges the extent of the current effects and potential for future disruptions to economic activity. Ultimately, the full effects of the outbreak will be determined by the degree to which the virus can be contained and the ability to develop a vaccine. Both of these remain unknown.  Extreme caution is warranted.

Leading indicators were mostly unchanged in February

The AIER Leading Indicators index rose to 54 in February. February is the tenth consecutive month within the 46 to 54 range for the Leading Indicators Index following a four-month run below neutral that hit a low of 25 in March 2019. The average over the last 10 months is 52.9, just barely above neutral. The near-neutral results suggest continued slow growth with elevated downside risks.

Just one indicator changed direction in February as real new orders for nondefense capital goods excluding aircraft improved from a negative trend to neutral. Among the 12 leading indicators that make up the Leading Indicators Index, six are trending higher, five are trending lower and one is neutral. The nearly balanced results are indicative of the varied performance of the major sectors of the economy.

Across the broad categories of indicators, results are mixed. The two labor market indicators, initial claims for unemployment insurance and average workweek in manufacturing have offsetting trends with claims trending favorably but average workweek trending lower. Heavy-truck unit sales were trending lower, offsetting the neutral reading from new orders for core capital goods indicator. Among the financial indicators, debit balances in margin accounts and the Treasury yield spread indicator were unfavorable in February. However real stock prices were still trending favorably (though that is likely to change next month given recent stock price movements).

On an upbeat note, consumer-related indicators were tilted positively as real retail sales and food services, real new orders for consumer goods, and the University of Michigan Index of Consumer Expectations were all trending higher.

The Roughly Coincident Indicators index fell 17 points to 75 in February from 92 in January. Despite the significant decline, just one indicator changed signal in February. The Conference Board’s consumer confidence in the present situation indicator weakened from a positive trend in January to a negative trend in February. That move left the index with four roughly coincident indicators in uptrends while one was neutral and one was in a downtrend.

The Lagging Indicators index fell 8 points in February to a reading of 42, the lowest result since June 2019. Among the six lagging indicators, just two were trending higher while three were trending lower and one was neutral. The core consumer prices indicator weakened from a favorable trend to a neutral trend in February.

Coronavirus Situation Report

Information about the outbreak of COVID-19 is changing continuously (officially, the virus has been named “SARS-CoV-2” and the disease it causes has been named “coronavirus disease 2019,” abbreviated “COVID-19”.) The World Health Organization (www.who.int) and the U.S. Center for Disease Control (www.cdc.gov) provide regular updates on the outbreak.

According to the World Health Organization, the first patients were reported to it by China on December 31, 2019. From sometime in mid-to-late December, COVID-19 has spread to approximately 90,000 people in 65 countries causing more than 3,000 deaths. The vast majority of confirmed cases and deaths are in China. Other hot spots include Republic of Korea (South Korea), Italy, and Iran, which account for a combined 7,000 confirmed cases and 111 deaths. In the U.S., there are 60 confirmed cases with 6 deaths across 12 states.

Significant efforts to contain the spread of COVID-19 are underway. Travel restrictions and quarantines are being implemented around the world. Those efforts are having direct effects on economic activity. Furthermore, reactions by people around the world have altered daily routines including travel, work, and spending patterns.

Economic Implications

While it’s too early to gauge the full impact of the outbreak, numerous public companies have already announced disruptions to supply chains, production, and sales. Financial markets have reacted sharply with equity markets falling 10 percent or more. Bond markets have seen yields on safe assets drop, including the U.S. 10-year Treasury note yield which fell below 1.0 percent for the first time ever following an emergency rate cut by the Federal Reserve. The Fed lowered the target range for the fed funds rate by 50 basis points to 1.00 percent to 1.25 percent.

For the most part, economic statistics in the U.S. have yet to reflect the outbreak. Monthly statistics for March will begin to be published in April, though the latest surveys from the Institute for Supply Management noted widespread comments about the unfolding outbreak, and the University of Michigan Survey of Consumer Sentiment will publish a preliminary estimate in mid-March. High frequency data such as initial claims for unemployment insurance and weekly same-store retail sales are holding at pre-outbreak levels.

Overall, the COVID-19 outbreak represents a major threat to the U.S. and global economies. There is an increasing likelihood that first-quarter growth in the U.S. and around the world will slow dramatically and could turn into a contraction – possibly a severe contraction. Extreme caution is warranted.

Manufacturing Sector Remains Fragile

The Institute for Supply Management’s Manufacturing Purchasing Managers’ Index fell to a 50.1 percent reading in February, down from 50.9 percent in January. The February result was the second month just barely above the neutral 50 threshold following five months below neutral.

Among the key components of the Purchasing Managers’ Index, the New Orders Index came in at 49.8 percent, down from 52.0 percent in January. February returned to a below-neutral level after turning positive in January. January was the first month with a reading above 50 percent following five months below neutral. The results suggest production as measured by the Federal Reserve’s industrial production for manufacturing index may continue to be weak in the coming months.

The production index was at 50.3 percent in February, down from 54.3 percent in January. The weaker performance for production contributed to an increase in the backlog-of-orders index. That index came in at 50.3 percent in February, up from 45.7 percent in January.

Consumer Price Increases Accelerate

The Consumer Price Index posted a 2.5 percent increase for the 12 months through January. The historically volatile food and energy categories had gains of 2.0 and 6.9 percent respectively while the core consumer price index, which excludes food and energy, increased 2.3 percent. These increases are a bit faster than the 5-year annualized gains of 2.0 percent for the consumer price index, 1.8 percent for food, and 1.9 percent for energy. The 5-year rate for the core consumer price index was 2.1 percent.

Key areas accounting for much of the persistent increases include owners’ equivalent rent, tobacco, medical care (particularly hospitals), and food services. Owners’ equivalent rent accounts for about 24 percent of the consumer price index and has posted a five-year annualized increase of 3.3 percent. A unique attribute of owners’ equivalent rent is that there is no actual transaction. The number represents what a homeowner theoretically would pay to rent their home to themselves. An argument can be made that including a category with such a significant weight yet no real underlying transaction inaccurately boosts the final index. If food, energy, and shelter were excluded from the Consumer Price Index, the 12-month gain would be just 1.5 percent, while the five-year annualized pace of increase is just 1.3 percent.

Among the other significant contributors, tobacco prices are up 5.4 percent for the year and 4.6 percent annually over the last five years; medical care is up 4.5 percent for the year and 3.0 percent over five years with hospital services up 3.8 percent and 4.0 percent, respectively; and food services are up 3.1 percent over the past 12 months and 2.7 percent annually over the past five years.

On the opposite end of the spectrum, the Consumer Price Index for all goods except for food and energy goods is down 0.3 percent for the past year and down 0.2 percent annually over the last five years. Overall, consumer prices have been increasing at a slightly faster pace. Energy continues to be volatile, but within the core consumer price index, goods prices are generally falling (except for tobacco) while services, particularly housing and medical services, are rising.

Commercial bank lending has been moderate

Commercial banking institutions in the U.S. increased total loans and credit outstanding by just 0.1 percent in January, resulting in a 12-month rise of 4.2 percent. That is less than half the pace of credit growth over the two years prior to the last recession. Excessive credit growth can be a significant problem during economic expansions; however, the current pace of expansion appears moderate.

Among the major segments, residential mortgages, consumer loans, and commercial real estate loans have been growing in a range of 2.5–6 percent over the past year, up from a range of 1.5–5 percent at the beginning of 2019. The notable exception is commercial and industrial loans which grew at a 1.2 percent pace over the past year, down from a 10.4 percent pace for the 12 months ended February 2019. The latest survey of senior loan officers at commercial banks suggests loan demand remains solid for residential mortgages but generally weak for commercial and industrial loans.

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Robert Hughes

Bob Hughes

Robert Hughes joined AIER in 2013 following more than 25 years in economic and financial markets research on Wall Street. Bob was formerly the head of Global Equity Strategy for Brown Brothers Harriman, where he developed equity investment strategy combining top-down macro analysis with bottom-up fundamentals. Prior to BBH, Bob was a Senior Equity Strategist for State Street Global Markets, Senior Economic Strategist with Prudential Equity Group and Senior Economist and Financial Markets Analyst for Citicorp Investment Services. Bob has a MA in economics from Fordham University and a BS in business from Lehigh University.

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