Don’t Expect a Full-On Recession

Recent economic news has been good, but leading indicators signal a softening in 2014. We forecast a mild, and brief, recession in U.S. industrial production next year, as opposed to a full-on recession.

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Recent economic news has been positive. Factory new orders are up on machinery and computer orders, auto retail sales are doing well generally and Chrysler sales hit a six-year high, the stock market is moving higher, construction remains positive, and there is a generally positive outlook regarding U.S. GDP in the coming quarters. We anticipate that U.S. industrial production, our benchmark for overall economic activity, will continue growth through the remainder of 2013.

The Federal Reserve Board has been in the news a lot lately, and that has created quite a bit of handwringing over whether the Fed would slow down on its $85 billion monthly bond purchases this year with a complete cessation by mid-2014. The situation has been a bit strange in that good news in the economy would lead the Fed to taper its quantitative easing, but the stock market would view the tapering as a negative, despite the fact that the Fed decision would be predicated on good news. Bad news in the economy would keep the Fed spending, and the stock market seems to prefer more Fed money to assurances of a strengthening economy.

Let’s look at both the Federal Reserve Board and the stock market and see what each means to us as business leaders and as individuals.

The decision to let up on quantitative easing is predicated upon the achievement of sustainable growth in the U.S. that will last into 2014. There must be a strengthening economy for the Fed to withdraw what they believe is their beneficial support. Given that qualifying statement, do not expect the bond-buying program to do more than slow down later this year. The U.S. economy will be softening in 2014 and that will keep the Federal Reserve from going to zero. The stock market will like that. Many business leaders might also view this as positive news. We do not, but perception can be greater than reality, and the perception will help keep the economy from tanking next year. The leading indicators are clearly signaling a softening in 2014. We are forecasting that there will be a mild, and brief, recession in U.S. industrial production next year, as opposed to a full-on recession.

The S&P 500 gave up some ground from May to early July. The 1.5 percent decline is not statistically meaningful at this time. It would seem that one of the best known and most watched leading indicator signals is suggesting better days ahead. Many people think the healthy first-half-2013 stock market rise means we will have a good 2014. However, the S&P 500 isn’t saying anything about 2014 (yet). There is generally a six-month leadtime between the stock market and the general economy (as measured by U.S. industrial production or GDP). The S&P 500 trend through May indicates that the economy will avoid slipping into the backside of the business cycle until late this year. The one-month decline in June could be signaling that we are on track with our outlook for a softer economy in 2014, and potentially a mild recession awaits us.

We don’t try to time stock market highs and it is too early to say if May will hold as the S&P500 high for this business cycle. We don’t need to know exactly when the peak is going to happen because it is possible to preserve accumulated wealth derived from the market by either taking your profits off the table now (selling) or protecting your equity positions so you won’t be swallowed up in a downdraft (trailing limit orders). Now is a good time to assess your risk and take action accordingly based on an expectation of a normal amount of decline in share prices. A normal bear market constitutes a peak-to-trough drop in the S&P 500 between of 16.1-34.1 percent. A 24.2 percent decline is a typical downward move.

Capital good shipments in the last quarter improved to 2.3 percent above the same time last year, a solid improvement from April’s weak 0.6 percent growth rate. The monthly figures have vacillated of late, with April posting a steep decline and May showing the steepest April-to-May increase in 20 years. Inventory levels are slowing in their rate of rise and unfilled orders for the quarter are 3.4 percent ahead of last year. It is noteworthy that unfilled orders are 3.4 percent ahead of this time last year while shipments are 2.3 percent above. The healthy order activity and the external leading indicator input bode well for Automation World readers in the coming two quarters.

There is a growing disparity between nondefense capital goods new orders and defense capital goods orders. Nondefense new orders are 0.5 percent below this time last year for the last 12 months but 2.4 percent ahead of last year when we focus on the last quarter. The quarterly orders figure has risen 14.8 percent since the September 2012 low, making this the best increase since 1982-85. Readers on this side of the fence should be busy quoting and closing their share of orders. Expect an active environment ahead, but do not overreach in terms of sales planning. The total industry capitalization utilization rate stands at 77.6 percent, down from the 80.1 percent utilization rate enjoyed in the robust 2005-07 period. Process improvement, efficiencies, and regulatory requirements will be key to sales success, as opposed to the rapid economy growth of 2005-07.

Defense capital goods new orders appear stronger over the last year with a 4.2 percent growth rate (as opposed to 0.5 percent for nondefense), but the quarterly activity is dismal with a 22.6 percent year-over-year decline. The quarterly new orders trend has dropped to the lowest level in almost six years, with more decline anticipated. Federal budget problems are not expected to go away anytime soon. Expect a tough sales environment with stiff competition on the defense side of the economy.

>> Alan Beaulieu, alan@itreconomics.com, is President of the Institute for Trend Research (ITR). The ITR blog can be found at www.itreconomics.com/blog.

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