U.S. on the brink of re­ces­sion

Financial Mirror (Cyprus) - - FRONT PAGE -

Full steam ahead, then? Fri­day’s re­lease of the first GDP es­ti­mate for 3Q16 head­line showed US growth ris­ing to an an­nu­alised 2.9%, up from 1.4% in 2Q and 0.8% in 1Q. On the face of it, this read­ing points to the US econ­omy emerg­ing from yet an­other soft patch, and so back­ing away from the re­ces­sion fron­tier. Not so fast. A close look at the un­der­ly­ing com­po­nents of the GDP re­port re­veals the US as be­ing per­ilously close to that thresh­old.

Firstly, the pri­mary con­trib­u­tors to the ap­par­ent pick-up in growth (ex­ports and in­ven­to­ries) are un­likely to last. Ex­ports rose 10% QoQ (an­nu­alised), adding 1.2 per­cent­age points to growth—af­ter con­tribut­ing al­most noth­ing in the prior two quar­ters. Yet, this fil­lip was due to a likely one-off rise in food ex­ports as US farm­ers re­sponded to a weak soy­bean har­vest in Ar­gentina and Brazil. As that ef­fect fades, US ex­port growth will again look weak, weighed down by a strong US dol­lar and ris­ing labour costs.

Equally fleet­ing will be the pos­i­tive con­tri­bu­tion from in­ven­tory building (+0.6 per­cent­age points in 3Q, from -1.2pp in 2Q). In­ven­to­ries are still high rel­a­tive to sales, so while this volatile series will oc­ca­sion­ally tick-up, neg­a­tive con­tri­bu­tions will be the norm un­til the in­ven­tory over­hang is worked off (and lit­tle progress has been made thus far).

If that were the end of the story, we would sim­ply pour cold wa­ter on the idea that growth is ac­cel­er­at­ing—noth­ing more. Alas, there is more to worry about. Pri­vate in­vest­ment (res­i­den­tial and non-res­i­den­tial) has quit grow­ing. My­self and Tan Kai Xian have pre­vi­ously ar­gued that US home­build­ing of­fers the best lead­ing in­di­ca­tor for over­all growth. This is prob­a­bly be­cause the hous­ing sec­tor is very in­ter­est-rate sen­si­tive (and the eco­nomic cy­cle is largely a credit cy­cle). Hous­ing is also sen­si­tive to con­sumers’ in­come growth and con­fi­dence lev­els, and fi­nally new home pur­chases lead to re­lated pur­chases such as fur­ni­ture and white goods. Hence, it was wor­ry­ing to see the home­build­ing part of GDP (i.e. res­i­den­tial–fixed in­vest­ment), fall at an an­nu­al­ized –6.2% in 3Q, af­ter a –7.7% de­cline in 2Q. Th­ese falls have low­ered res­i­den­tial in­vest­ment growth be­low 1% YoY (black line in the chart). When res­i­den­tial in­vest­ment con­tracts, it usu­ally in­di­cates a re­ces­sion is close. If at the same time busi­ness cap­i­tal spend­ing is con­tract­ing (blue line), then his­tory sug­gests a re­ces­sion is al­ready un­der­way. With busi­ness cap­i­tal spend­ing ba­si­cally flat YoY, Fri­day’s GDP re­lease shows an econ­omy that is on the brink of re­ces­sion.

In the next twelve months, the two most likely sce­nar­ios are:

1) The US slips into re­ces­sion. In ‘The Ris­ing Odds Of A US Re­ces­sion’, it was pointed out that the la­bor mar­ket seems to be top­ping out and close to giv­ing re­ces­sion sig­nals. As of Fri­day, the same can be said of US in­vest­ment data.

2) Growth re­bounds, but in the con­text of ris­ing in­fla­tion this causes a bond mar­ket correction. The tem­po­rary re­prieve of growth con­cerns could be good for eq­uity mar­kets, but a sell­off in the bond mar­ket would not be (1987 any­one?).

To­day, I of­fer sim­i­lar odds for both sce­nar­ios. Ei­ther way, in­vestors should pre­pare for a changed in­vest­ment en­vi­ron­ment by re­duc­ing eq­uity risk ex­po­sure and short­en­ing the du­ra­tion of fixed in­come port­fo­lios.

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