Weekly Indicators for October 21 - 25 at Seeking Alpha

 

 - by New Deal democrat

My “Weekly Indicators” post is up at Seeking Alpha.

Ever since - and in response to - the really good jobs report early this month, interest rate yields on bonds have crept back up, giving back most of their summer gains. That puts some pressure on the long leading indicators. Also importantly, so far - with close to 40% of companies reporting - Q3 corporate profits have not shown any gains compared with Q2 profits. 

As usual, clicking over and reading will bring you up to the virtual moment on all of the important leading and coincident economic data, and will reward me with a penny or two for collecting and organizing it all for you.

Why has the inverted yield curve failed? A fundamentals-based explanation

 

 - by New Deal democrat

Prof. Menzie Chinn at Econbrowser, like me, is an Old School blogger, and like me, is focused on forecasting. 

Yesterday he wrote a piece about supplementing the yield curve with a second condition, the private nonfinancial debt service ratio. Basically, what percent of income is needed to service debt. Doing so retrospectively indicated far less of a chance that the economy would fall into recession between 2022 and now.

I am always a little concerned about “just so” indicators that retroactively fit something without either a fundamentals’based justification, or a testable prediction for the future. So let me venture into that territory in this post.

There has always been discussion about why exactly an inverted yield curve should indicate a recession is oncoming. The best explanation I have heard is that banks borrow short (from depositors) and lend long. An increase in short term rates means that banks must pay out more in deposit rates, and that means less lending, because to earn a profit those rates must increase as well. Less lending in turn is a factor in an industrial slowdown, which leads to recession.

That paradigm is best shown by comparing the 10 year minus 2 year Treasury spread (I could use other spreads as well) (blue in the graph below) vs. whether banks are tightening or loosening commercial lending conditions (red, inverted so that tightening shows as negative, /10 for scale):

Historically when the yield curve has inverted, lending has tightened. That did happen in 2022 and early 2023, but pressure to tighten lending conditions eased up beginning in Q3 2023 - something that typically has happened coming *out* of recessions, rather than going in to one.

One reason why this may have been the case has to do with supply chain tightness. The NY Fed’s Supply Chain tightness Index is shown below in two installments (a positive value indicates increased tightness):

Note that before 2020 this index had almost never, even during the Great Recession, had a value higher than 1. But beginning in 2020 through 2022 it rose to levels as high as 4.5. Since the beginning of 2023 it has resumed being completely normal.

The return to normalcy meant the supply curve shifted sharply to the left. Commodity prices on average fell by almost 10% YoY - a hurricane force tailwind behind producer profits. Nonfinancial producers hardly had to worry about bank lending conditions.

And despite the lending conditions survey data shown above, financial conditions adjusted for background conditions (blue in the graph below) or as affecting leverage (red) both remained very positive (again, for these indexes negative = loose) for the entire duration of this expansion, with the brief exception of the Silicon Valley Bank failure in early 2023:

A similar result is obtained from the St. Louis Fed’s Financial Stress Index (again, negative = less stress):

Aside from the tailwind provided by the un-kinking of the supply chain, another major factor may be the interest earned by banks on their Fed reserve deposits, which has been allowed since 2008 (blue in the graph below), in contrast to their CD rates (red):

During the entire period that the Fed raised interest rates, banks could earn substantially higher interest on their money parked with the Fed, than they had to pay out to depositors.

Under those conditions, who cares if the Fed rate hikes have inverted the yield curve?

The above has been a look at the economic fundamentals of why the inverted yield curve gave a poor signal in the past several years. And it is testable. *If* (1) the supply chain index remains within its normal limits, and (2) bank deposit interest rates exceed the interest rate paid by the Fed for bank reserves, *then* the financial stress indexes should indicate higher stress, and an inverted yield curve will again forecast a recession.  If that doesn’t occur, a recession is not likely.

We’ll see.

Rebalancing of the housing market, new home sales edition: sales increase, prices firm

 

 - by New Deal democrat

Yesterday we got the existing home sales portion of the rebalancing of the housing market, showing sales down further, and price growth attenuation. This morning we got the new home slice, which was a virtual mirror image.

As per usual, while new home sales are only about 10% of the housing market, they are the most economically important because of all the new economic activity involved in construction, landscaping, and furnishing. And my usual caveat: new home sales are the single most leading metric for the entire sector, but they suffer from the fact that they are extremely volatile and also heavily revised. So it is best to look at them in comparison with single family permits, which are almost as leading and have a much better signal to noise ratio.

On a month over month basis, in September new home sales rose 4.1% from a downwardly revised August. June and July were also revised slightly downward. On a three month moving average basis, they are at their highest level since early 2022 (blue in the graph below). As you can see, in the past several years single family permits (red) have followed with a several month delay. This morning’s report adds to the evidence that June of this year was their bottom:

And as usual, sales (blue again) lead prices (red, right scale):

The boom in prices followed the boom in sales, and as sale cooled off sharply, prices stalled. Here is the same data in a YoY format, which shows the leading/lagging relationship a little more clearly:

The trend in new home sales has been higher for about a year. Last month I concluded my overview by writing that “Prices are still lower YoY … but can be expect to move higher soon.” This month they were unchanged YoY, the first time the comparison was not negative since January.

For further forecasting purposes, note that historically inventory (“new single family homes for sale”, gold, right scale) lags actual sales. As a general rule, recessions do not happen until builders cut back on actual construction, and the number of houses for sale turns down:

Here is the close-up of the last five years. Inventory has continued to increase albeit slowly (up 2,000 this month):

There is no recession signal in this data.

In conclusion, yesterday and today continued to show the rebalancing of the housing market, as new home sales have increased and prices are firming, while existing homes, for which inventory had virtually disappeared, had a new 10+ year low in sales, with prices increases abating. It is entirely possible that YoY price increases in existing homes completely stop by the end of this year.

Weekly jobless claims return to near normal

 

 - by New Deal democrat

After two weeks of being highly elevated YoY, initial claims returned to a more “normal” range this week, as except for Florida, hurricane disruptions largely disappeared.

For the week initial claims declined -15,000 to 227,000. The four week moving average increased 2,000 to 238,500. With the typical one week delay, continuing claims rose 25,000 to 1.897 million:

On the YoY% basis more important for forecasting purposes, initial claims were up 6.6%, the four week average up 13.3%, and continuing claims up 4.8%:

We won’t have details on the state by state breakout this week until later, but we did get more visibility into last week’s number, as Florida’s claims increased by over 60% to over 10,000, while North Carolina’s initial claims had the biggest single decrease of any State. On a YoY basis both FL and NC were very elevated. Meanwhile both Michigan and Ohio returned to normal. 

Most likely the remaining part of the YoY increase this week will be discovered to be Florida in the wake of Hurricane Milton. Aside from that, while claims are higher than one year ago this week, they are well within the range of normalcy and not recessionary.

Finally, here is a look at how jobless claims are likely to play into the unemployment rate when the next jobs report is reported in two weeks:

I expect the hurricane distortions to put some upside pressure on the unemployment rate.

Rebalancing of housing market continues: existing home sales down, inventory up, price growth moderates further

 

 - by New Deal democrat

In the past number of months, I have been looking for a rebalancing of new vs. existing home sales. The sharp increase in mortgage rates beginning in 2022 locked many existing homeowners into their houses, since they could not afford the concomitant increase in mortgage payments that would accrue from moving. This depressed existing home sales, but drove up prices due to the very limited supply.

The “big” news this morning was that existing home sales made a new 10+ year low at 3.84 million annualized:

But as the above graph shows, this was hardly a plunge. Rather, sales came in at the bottom of their recent 18 month range.

But if there was no bright spot in sales, the YoY% change in prices continued to moderate (below graph shows non-seasonally adjusted data):

On a YoY basis, in response to the longer term decline in inventory, existing home prices have risen consistently since 2014, and accelerated during the COVID shutdowns. After briefly turning negative YoY in early 2023, troughing at -3.0% in May, comparisons accelerated almost relentlessly to a YoY peak of 5.8% in May of this year. Since then the YoY comparisons have decelerated to 4.1% in June, 4.2% in July, 3.1% in August, and 2.9% in this month’s report.

Meanwhile the inventory of existing homes continued to rise sharply. In August it was 22.7% higher YoY; in this month’s report it was 23.0% higher YoY (below graph shows absolute numbers, not seasonally adjusted):

Last month II concluded my review of both new and existing home sales by saying that “the rebalancing of the housing market is continuing, as lower mortgage rates help in the sales of new homes, which has helped drive down demand somewhat for existing homes, which in turn has led to an abatement in their price increases and an increase in inventory.” 

This month those trends all continued as to the existing home market. Demand has been driven even further down, despite somewhat lower mortgage rates. This again led to more inventory and a continued abatement in price growth. I expect these trends to continue for awhile. Tomorrow we will see if the slight upward trend in new home sales has continued.

Are corporate profits stalling in Q3?

 

 - by New Deal democrat

One of the well-established long leading indicators is corporate profits. Typically they peak a year or more before the onset of a recession. And the reason makes sense: if there is profit pressure that lasts longer than a single quarter, i.e., it looks like it may be forming a trend, firms might cut their output, and more importantly, they are much more likely to engage in cost-cutting measures including laying off employees.

Here’s the long term view (note graph in log scale), divided into two periods for easier viewing:

Only in the oil related recessions of 1974 and 1991 did corporate profits not decline before their onset. Through Q2 of this year, profits were still rising. We won’t find out about Q3 officially until the end of November.

One way to try to get a more current handle on the profit situation is to track what firms are reporting to Wall Street. This is well-covered in the financial press. Weekly graphic updates are provided by, among others, FactSet.

Wall Street analysts’ profit estimates follow a predictable path. They are extremely optimistic in the quarters well ahead of the present. As the actual quarterly reports get closer and closer in time, those estimates are trimmed downward. The late financial analyist Jeff Miller studied this, and concluded that profit estimates were most accurate three quarters in advance. Further out they were too optimistic; closer in time they were too pessimistic.

The biggest time for downgrades in analysts’ estimates are right before the actual reporting begins. Then, when actual profits are reported, they beat those severely downgraded estimates, creating an atmosphere of investor optimism, and (during expansions!) it is off to the racetrack once again.

The typical pattern was followed in the weeks just prior to the Q3 2024 reporting season, which began a couple of weeks ago. In late September S&P 500 total earnings per share were estimated at 61.16:

By two weeks ago, right before reporting began, they had declined to 60.63:

By last Friday 1 in 7 companies in the S$P 500 had reported earnings for Q3. If this quarter followed form, actual reported earnings per share should be beating estimates sufficiently to cause actual plus estimated earnings to start to rise.

But that’s not what has happened this quarter so far. Instead, actual plus estimated earning per share have continued to decline, as of last Friday down to 60.07:

That’s *not* typical at all. 

Of course, as the vast majority of companies report earnings over the next few weeks that decline could reverse sharply. But if the poor actual results persist, that’s a big negative for corporate expansion, including hiring, in the quarters ahead. 

One week from Thursday the first estimate of Q3 GDP will be reported. While it won’t include corporate profits, it will include a reasonable proxy in the form of proprietors’ income, which sometimes turns contemporaneously with profits and sometimes with a quarter or so lag. Here’s what that looks like, compared with corporate profits since the pandemic:

In the meantime, we’ll get another weekly update from FactSet this Friday, and we’ll see if the downturn persists or reverses as more companies report.

A closer look at (why I’m not terribly concerned by) the recent elevated initial claims

 

 - by New Deal democrat

This week is another light one for economic data, so let me discuss a couple of points explaining why I am cautious, but not DOOOMing. Basically, because there are a lot of asterisks.

Today let me follow up on initial jobless claims. The typical best way to look at these is YoY. If the percentage goes up by more than 10%, that’s worth a yellow caution flag. If it stays up more than 12.5% for at least two full months, that’s a red recession warning flag, although even in that case there are a few false positives.

In the last two weeks, initial jobless claims (gold in the graph below) have been higher by over 15%. Ordinarily that would be a fairly serious cause for concern. But there were several special situations at work.

First of all, Hurricane Helene caused issues in the panhandle of Florida and even more dramatically in North Carolina. As I have done in the past, my workaround is to exclude those two States and see what the YoY changes have been in the other 48 States (blue). Even using that workaround, claims have still been up over 15%. But it turns out there were labor issues in motor vehicle plants in Ohio and Michigan that also impacted the numbers. Excluding those States as well, the YoY% changes in the remaining 46 States only exceeded 10% in the last week (red):

Part of what is going on is the base problem, i.e., what was happening during October last year. Note in the above graph that the nationwide total during the week of October 14, 2023 were among the lowest all last autumn.

To further show that, here is the same graph, but showing absolute numbers as opposed to the YoY% changes:

On the far right side, we can see that Michigan and Ohio had a much bigger effect during the first week of October, and abated last week. Additionally, on the left side of the graph, which begins in September 2023, we can see that late September and October had the lowest numbers (not seasonally adjusted) at any point in the last 13 months. So the YoY comparisons are especially challenging, but will largely recede in the next few weeks.  

As I wrote above, a couple of bad weeks is not overly concerning when viewed on a historical basis. Here is the same YoY information for the 1980s through 2007:

Note that there were many times when claims YoY were higher by over 10% or even over 15%, but receded after several months without there being a recession thereafter. That’s why in forecasting I look to see if the big increase in claims persists for at least two straight months.

Finally, here is an update of my “quick and dirty” forecasting system using the YoY% change in the stock market at well as (inverted) initial claims:

It’s hard to argue that we are in a pre-recessionary environment based on a couple of poor weeks for initial claims while the stock market is higher by almost 40% YoY!