***RECESSION WATCH

U.S. Economic Growth Hampered By Recent Hurricanes Retail sales declined 0.2% in August while industrial production both tumbled by 0.9%

A pair of severe hurricanes—Harvey, which hit Texas and Louisiana in late August, and Irma, which struck Florida in early September—are set to jumble economic indicators this fall.

Early evidence came Friday when the Federal Reserve reported that U.S. industrial production dropped a seasonally adjusted 0.9% in August from the prior month, its largest decline since the 2007-09 recession. The Fed said Hurricane Harvey was responsible for most of the decline by depressing oil drilling, petroleum refining and other industrial activity. (…)

The Commerce Department said it couldn’t isolate the effect of Hurricane Harvey on retailers last month.

And just to blur things up even more

• Hurricane Jose Could Threaten New York Next Week, NHC Says

Friday’s retail sales report for August was as important as it was bad. Yet, the various media I survey did not make much of it, perhaps thinking it was all Harvey’s fault.

Let’s deal with the easier stuff first:

• U.S. Industrial Production Reduced by Hurricane Harvey

The Federal Reserve indicated that storm damage curtailed the change in total industrial production, as well as the change in factory sector activity, by roughly 3/4 percentage point during August. Industrial production declined 0.9% last month (+1.6% y/y) following a 0.4% July gain, revised from 0.2%. Factory output fell 0.3% (+1.5% y/y) following no change in July, revised from -0.1%. (…)

That means IP would have decline 0.2% without Harvey, bringing the last 2 months to +0.2% (+1.2% a.r.) and the last 3 months to +0.4% (+1.6% a.r.). Most of the estimated impact from Harvey is in Utilities and Mining (O&G). Trends in most other sectors remain pretty dismal as Haver Analytics table shows:

Most worrying is Consumer Goods production which was almost flat in 2016, is down YoY in August and dropped at a 2.8% annualized rate in the last 3 months. American manufacturers of consumer goods have not increased their production since July 2015. Why? Lack of demand!

• Retail sales in downspin?

Harvey can probably be blamed for a very small part of the 0.2% decline in August retail sales but he claims innocence for all previous months’ reported and revised numbers:

• On July 17, June retail sales were reported down 0.2% after –0.1% in May. Ex-Autos, ex-gasoline, sales were down 0.1% the first decline in this measure in nearly a year. The U.S. consumer appeared spent out.
• On August 15, July retail sales were reported up 0.6% and June sales were revised from down 0.2% to up 0.3%. False alarm, the consumer is out there spending.
• On September 15, August retail sales were reported down 0.2% and July sales were revised from +0.6% to +0.3% and June was revised from up 0.3% to down 0.1%.

August data will surely be revised, up or down, but this is what we have at this point: Retail and Food Services Sales have totally stalled after January 2017 (+0.3% in the last 7 months, same ex-food). So far in Q3, sales are growing at a 0.6% annualized pace relative to the prior quarter (1.4%).

Retail control sales (excludes food, autos, building materials and gasoline and which is a direct input into GDP), declined 0.2% following a 0.6% gain in July. Control sales are running at a quarterly annualized pace of +1.3% compared to +3.9% in 2Q.

I have been writing on the very fragile state of the U.S. consumer throughout 2017 (recently in SEPTEMBER!), pointing out the widening divergence between income and expenditures and the resulting worrisome drop in the savings rate. Stated briefly, Americans have been overspending their income since early 2016, dissaving to the point where they now have little cushion to absorb any shock. Like Harvey and Irma if you live in the south, like a 14% spike in gas prices if you live anywhere in the USA.

From the September University of Michigan Survey of Consumers:

• buying intentions for autos dropped from 152 last April to 136, the lowest reading in 3 years;
• buying plans for homes went from 155 in April to 138 in September, lowest in 6 years;

This is happening right at the start of the most important period for the economy: back-to-school, Thanksgiving and Christmas. There’s an old saying in retail: “as back-to-school goes, so goes Christmas” …

Slow manufacturing of consumer goods reflect the absence of any momentum in new orders from merchants which reflect the absence of any momentum in consumer demand.

The chart below plots the YoY rate of growth in nominal retail sales and nominal GDP. Retail sales are still up 3.2% YoY but if they remain flat (seasonally adjusted) through December, like they have since January, the YoY growth rate will collapse to +0.8% at year end.

Merchants would find themselves overstocked and would further reduce their orders, killing consumer goods manufacturers in Q1’18.

This is how a U.S. recession could arrive without any direct contribution from the Fed.

But here’s how the Fed could contribute: rising debt + rising interest rates = problems:

• Rising credit card delinquencies to add to U.S. banks’ worries

(…) JPMorgan’s credit card delinquencies rose 1.16 percent in August from 1.15 percent in July, while Capital One reported a delinquency rate of 3.97 percent, up from 3.81 percent in July.

Discover Financial Services’ (DFS.N) monthly credit card delinquency rate rose to 2.1 percent in August versus 2 percent in July.

Overall, seasonally-adjusted credit card delinquency rates for U.S. banks rose to 2.47 percent in the second quarter from 2.20 percent a year earlier, according to New York Fed data. (…)

There has been a notable increase in the transition to serious delinquency levels primarily among borrowers with credit scores of below 660, the NY Fed said in a blogpost.

“It is not clear yet what effect it will have on the future. But historically it has been the case that once these delinquency rates start to rise, they can continue to rise,” Haughwout said. (…)

And banks halt lending, yaddi, yaddi, yadda…

Online sales can be blamed, but only to an extent. Overall demand is weak, even for toys:

• Toys ‘R’ Us Preparing for Potential Bankruptcy Filing Before Holidays Toys ‘R’ Us could file for bankruptcy as soon as the next few weeks, as nervous suppliers have tightened terms for the retailer ahead of the crucial holiday selling season, according to people familiar with the matter.

(…) In addition to shrinking sales and heightened competition, Toys ‘R’ Us has been burdened with debt from a leveraged buyout 12 years ago. (…) A Toys ‘R’ Us restructuring would add to a list of more than 20 retailers, including RadioShack and Payless Shoe Source, that have filed for bankruptcy since the beginning of 2017. Another big box chain, Staples Inc., recently agreed to be taken private in a leveraged buyout. (…)

Some large toy brands, such as Lego and Star Wars, have also struggled recently, while the collectible Shopkins toys, which Toys ‘R’ Us helped launch, is on the downswing. Earlier this month, Lego AS reported its first decline in sales in 13 years and said it would cut 8% of its workforce. Another toy maker, Mattel Inc., replaced its chief executive earlier this year after a slide in holiday sales. (…)

Hopefully, these won’t slip any further (from The Daily Shot):

  

The ECRI Weekly Leading Index has turned sharply lower, totally unnoticed by equities (chart from Ed Yardeni)

From the ECRI blog:

(…) Most believe recessions are caused by shocks that then propagate through the economy. In contrast, our research shows that endogenous cyclical forces periodically open up windows of vulnerability for the economy, and that, once it is cyclically vulnerable, almost any exogenous shock can easily tip it into recession. Because such shocks tend to arrive sooner or later, an economy’s entry into a susceptible state is almost always followed by recession. (…)

Needless to say, the debate on the Fed’s next moves will only intensify, within and without the Fed. The economy is clearly weak and could quickly get a lot weaker. Forthcoming eco data will be very noisy and the Fed is split on the real inflation trends. Unlike the bond market:

• Fed to play it safe in face of inflation jitters Focus remains on cutting debt as higher employment fails to have expected effect

Sorry, You Are Probably Not Getting a Raise Next Year Businesses plan to keep budgets for raises relatively flat in 2018, while devoting more dollars to performance-based pay, a new survey says.

Eurozone Wage Growth Hits Two-Year High The pace of wage growth suggests inflation may be set to accelerate

(…) Eurostat said wages were 2.0% higher in the three months through June than a year earlier, the fastest rise since the first quarter of 2015 and up from 1.3% in the previous three-month period. (…)

Friday’s figures follow data released earlier this week that showed the number of people in work across the eurozone rose 0.4% during the second quarter, and at 155.6 million was the highest number ever recorded. With more people in work, and earning more, spending power is on the rise, a boost for the eurozone’s growth prospects. (…)

Economists Boost Euro-Area Outlook, See Best Year in a Decade

SENTIMENT WATCH

• Bull Market Switches From Dips to Tips

(…) More and more investors are piling into stocks that are rising rather than buying those that are falling:

(…) The question is whether this is a problem. Market breadth, which measures the number of stocks that are rising, can be a sign of market vitality or weakness. And volume is another way to look at market breadth. So receding volume flows into declining stocks could be a worry. But there are a number of reasons not to be concerned, at least not yet. First, market breadth overall has not been shrinking. Of the S&P 500, 355 are up through mid-September. That’s slightly more than the 332 that were up at this time last year and far more than the 191 that were up in the first eight and a half months of 2015.

(…) the rise of passive investing has most likely blurred all of these technical market indicators. (…)

• Ned Davis Research shows that demand volume remains greater than supply volume (via cmgwealth.com) :

The bull market has turned into the Seinfeld market. During every episode, investors are watching for something to happen. When nothing happens, especially nothing bad, investors are bemused and show their appreciation by throwing more money at the bull. (Ed Yardeni)

• Lowry’s Research confirms that demand is winning the volume tug-of-war:

Selling Pressure not only dropped [last week], but reaffirmed its long-term downtrend by recording its lowest reading since the start of the bull market in 2009. Thus, the rising Supply historically associated with an approaching major market top is currently nowhere in evidence. At the same time, Demand is expanding on both a short and intermediate term basis. That is, Buying Power has resumed its long term expansion, while the Short Term Index (which measures the shorter term trend in Demand), has recently shown its most rapid expansion since the market rally from the Nov. 2016 low. Thus, this week’s new highs in the major price indexes have been confirmed by an ongoing contraction in Supply and expansion in Demand – a pattern that has historically provided investors with the best opportunities for new buying.
        

• Nonetheless, overall volume keeps declining as Ed Yardeni shows:

BITCOIN

• (Mohamed A. El-Erian)

M.B.A. Applications Decline for Third Year in a Row Applications to full-time M.B.A. programs in the U.S. fell for a third straight year, the latest signal that business schools are struggling to entice young professionals out of a strengthening job market.