This daily economic journal is written in conjunction with weekly economics updates for our investment clients at nVest Advisors, LLC, It is copyright and may not be republished in whole or in part without written permission.
This information is also not a solicitation to do business with me as a financial advisor, though for the right readers, that offer is available. It is intended solely to provide timely economic data and analysis from the vantage point of a 15-year industry veteran (but also, always still a student) of personal finance and economics.
I highly recommend you read the past few weekly economic updates that I write for my financial advisory firm, nVest Advisors, LLC to get brought current on what’s happening in the broader economy, because this journal will be jumping right in without too much of a primer. I will be writing a primer into this blog as we go, but for now, the best place to catch up on what’s happening (and it’s a lot) is to read the macro blog at nVest.
Monday and Tuesday, March 27-28, 2023
Kind of a slow past couple of days in economic news, but we did get a look at Dallas Manufacturing and an interesting correlation between financial conditions and market participation.
Manufacturing and Service Activity
First, Dallas manufacturing, just like Empire State and Philly indexes last week, showed slowing and deeply contractionary manufacturing activity for the South-Central United States. It’s not surprising to anyone who has even a semester of college-level macroeconomics under their belt, but for whatever reason, these indexes always seem to “surprise” the experts every month. One thing you learn about financial analysts and economists is that they get VERY stuck on models that they’ve used for years or decades, and as such, their confirmation bias tends to get in the way of actually seeing what’s happening.
Economic activity rarely free-falls like that we saw in 2020, when the government shuttered the entire economy and we all sat around wearing face masks, unable to even visit Grandma. Instead, they tend to “step down” for a while, with the last step being the doozy. Although the shaded area in purple looks like an improving situation (higher highs and higher lows), a heavy reliance on the short-term trend (recency bias) is what gets economists in trouble when assessing the real state of the world. Let’s see this Dallas figure rolled into the national one:
Now we can see that total US manufacturing increased, though still contractionary, over the last couple of months, but still tending down in the larger channel since 2021 when inflation was first becoming a problem. Will this trend continue? Not likely. As financial conditions tighten in the coming months, and banks further restrict their lending requirements (see yesterday’s article), I anticipate this activity to quickly erode as the US and much of the world heads into recession later this year.
A large part of the manufacturing index contains components called Durable Goods, and Capital Expenditures (or Capital Orders). These are major equipment or appliance purchases that individuals or companies make on equipment that isn’t used up quickly, and might instead be serviced over a prolonged service life. A Durable Good you might own is a refrigerator. One bought by a company might be a large generator or building air conditioner units, walk-in freezers, etc.
Capital expenditures are purchases companies make that are meant to expand business operations. A new fleet of delivery vehicles, or investment in expanded factory capacity, etc. As you can see, both of these kinds of purchases, while still barely neutral, have significantly declined since the free money giveaways our government did during the Covid pandemic. The long-term trend is lower for both.
However, both of these numbers are actually MUCH worse than they look at first glance due to inflation. Whenever we look at sales data, we need to keep in mind that they can skew what’s really going in if prices have gone up substantially, as they have since 2020. NOMINAL numbers are just today’s numbers with those higher prices still in them. However, if we remove the currently elevated prices, we can see more clearly whether production is actually going up, or if it just looks like that because prices on each item are higher. When you strip away the effects of inflation on the final sales price, you get what is called the REAL number.
This is important to know because if you sell 1,000 trucks last year, your factory was busier and your customer base was stronger than if you only sell 850 this year, even if the price you charged for the finished product was higher.
So when we remove the effects of inflation, we go from the black line to the blue one. In truth, companies bought far fewer capital goods compared to pre-Covid levels; they’ve just paid a lot more for them. This is one reason why the prices of the products they make to sell you, skyrocketed.
Also, remember that these are lagging indicators – a month old, or more. So to get any real look ahead, we need to ask what the plans are for companies to make these kinds of purchases in the coming months. And that picture isn’t pretty. The blue line below is the intention of companies to make a major purchase in the months ahead. (The black line is that REAL Capital Goods number again):
Bottom line, manufacturing is NOT healthy, and continues to deteriorate. Now, for companies that make services (everything from software to restaurants to banking to Uber drivers):
Again, this looks like things are trending up, NOMINALLY. Since services can often be tapered, and not shut down completely like a factory order (it’s hard to order 2/3 of an air conditioning unit), the services sector may see a slower decline into the recession than manufacturing will.
Another thing to remember about these numbers in production is that, like most economic figures, these are a month old at least before we see them. When we look at what companies are planning to do in the near future, like making announcements about hirings or layoffs, a more accurate picture of the trajectory can emerge. Here are the top job cut announcements by sector in the US:
Far and away, the industry cutting the most jobs is Tech, media and telecommunications (all in the Service sector), but Consumer products and healthcare (Service), Financial (Service), and Retail, Transportation, and Warehousing (all Service) are trending above Industrial in terms of announced layoffs.
So while Service had a good PMI print last month, the companies themselves are saying things are getting much worse, not better.
One last anecdotal indicator that the service sector is not actually faring well is the office vacancy rate. Yes, many companies are opting to allow more telecommuting opportunities, particularly since Covid, the fact that office vacancies have soared in just the last year, when all of the Covid-related restrictions were lifted, makes this more of an economic indicator than a long-term change in corporate culture. The last time office vacancies were this high was at the end of the 1970s, in which the US was also in a long-term, inflation-fueled economic malaise (it sure wasn’t telecommuting or a pandemic in the 70s).
Banks are substantially tightening lending standards
Another trend that most definitely WILL slow the economy is that banks are now tightening the requirements to borrow money and the higher interest rates you’ll pay to do so. Here we can see that banks are substantially raising the standards to get a credit card and an auto loan (both are seeing huge increases in delinquent payments already). And while mortgage lending standards appear to be the same as the last few quarters, the interest rates on a new home loan is not allowing nearly as many people to qualify, and the higher mortgage payment is keeping a lot of potential buyers away.
It will be the loss of cheap leverage (debt) that will do the most damage to economic output, and we are finally seeing banks respond to the worsening economic conditions by requiring much higher standards of its borrowers before it lends. This will mean factories may not expand operations or even find it difficult to pay their own bills on time, which will slow their output, cause layoffs, etc.
See you tomorrow!