June 12, 2016
As we travel the highways this summer we are likely to encounter many construction zones as crews repair wear and tear, and the damage that results from the temperature cycle of freeze and thaw. There are a few hitches on the economic road as well.
I look to the Purchasing Manager’s (PM) Survey each month for some advance clues about the direction of the economy. Like the employment report, this month’s survey contains some troubling signs. I had my doubts about the low numbers in the employment report until I saw the results from this survey. PMs in the services sectors reported a 3.3% contraction in employment growth so that it is now neutral, matching the lack of growth in manufacturing employment.
New orders in both manufacturing and services are still growing but slowed considerably in the services sectors. The slowdown in both employment and new orders in the services sectors is apparent from the graph below. While this composite is still growing (above 50), it has been below the five year average for four out of five months.
This recovery has been marked by, and hampered by, a familiar peak and trough pattern of growth. Last month I wrote:
“A break in this pattern would indicate some concern about a recession in the following six months. What is a break in the pattern? An extended trough or a continued decline toward the contraction zone below 50.”
The CWPI, a custom blend of the various parts of the ISM surveys, shows a continued weakening that is more than just the periodic trough. If there are further indications of weakness this summer, get concerned.
A few years ago the Federal Reserve introduced the Labor Market Conditions Index, or LMCI, a composite analysis of the labor market based on about twenty indicators published each month by several agencies. Because the report is released a week after the headline employment report, this composite does not receive much attention from policy makers, which is a bit of puzzle. Janet Yellen, chair of the Fed, has indicated that she and others on the rate setting committee of the Fed, the FOMC, rely on this index when determining interest rate policy.
One business day after the release of this month’s unexpectedly weak employment report, the LMCI showed an almost 5% decrease and is the 5th consecutive monthly decrease in the index.
Although this composite is fairly new, many of the underlying indicators have long histories and enable the Fed to provide several decades of this index. As a recession indicator, the monthly changes in this index tend to produce a number of false positives. However, if we shift the graph upwards by adding 7 points to the changes, we see a familiar 0 line boundary. When the monthly change in the index drops below 0 on this adjusted basis (actually -7), a recession has followed shortly.
We are not at the zero boundary yet, but we are getting close and the pattern looks ominously familiar. Don’t play the Jaws music yet, though.