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U.S. economic data has deteriorated a little bit over the past 2 months. Some perma-bears are freaking out as usual. Fortunately, this deterioration isn’t significant enough to cause a recession. (Recessions lead to significant corrections or bear markets. Our medium-long term model can differentiate between recessions that cause significant corrections and recessions that cause bear markets).
The recent weakness is most evident in Citigroup’s Economic Surprise Index, which aggregates economic data beating/missing analysts’ expectations. Retail sales, housing, industrial production, manufacturing, etc have all missed analysts expectations over the last 2 months.
The question is, why has U.S. economic data deteriorated a little recently? There are 2 answers: a simple one and a complicated one.
The simple answer
The economy has normal and random fluctuations. No economic expansion goes up in a perfectly linear line. There are always spurts and sputters along the way. Most instances of small economic data deterioration are random and cannot be predicted.
As you can see in the above Citigroup chart, the economic data always deteriorates every once in a while, even during strong stock market rallies.
Small economic deterioration can end in a heartbeat. The economy can return to a pace of healthy growth on a dime.
- Every single piece of economic data in August 2010 missed expectations. But starting with the September 1 ISM manufacturing data, every piece of data started to beat expectations.
- The U.S. economy deteriorated a little bit from September 1995 – January 1996. The S&P completely ignored this slight deterioration and rallied like crazy during this period. Starting with the January 1996 Jobs Report (released in early-February 1996), every single piece of economic data improved and beat expectations.
The complex answer
There’s a small deterioration in the economy right now because the economy is transitioning. The U.S. economy is transitioning into the final stage of this economic expansion. Hence, old drivers of economic growth are going out the window, and new drivers are about to set in. Let’s break down the various economic data.
The U.S. housing market dipped a little recently. New Home Sales, Housing Starts, and building permits have all fallen a little. There is a simple reason for this:
Over the past 8 years, the housing boom has mainly been driven by investors seeking to cash in on the rental market. Both domestic and foreign buyers have snapped up apartment units (for rent) and high end detached homes (e.g. wealthy Chinese buyers). Hence, Housing Starts and New Home Sales have been low. In order for Housing Starts and New Home Sales to be high, a lot of cheap starter homes (for young families) need to be built. Housing Starts and New Home Sales only look at volume – not the price of homes that are built and sold.
But thanks to a change in demographics, millennials are finally at the family-starting age. As millenials move out from rental apartments and start to buy starter-houses, the U.S. housing market will continue to improve over the next few years.
We are starting to see this shift in the housing market already. Housing Starts (housing construction) is split into 2 parts:
- Multi-family units (i.e. apartments)
- Single-family units (i.e. houses)
Over the past 8 years, multi-family starts led the increase in Housing Starts. But over the past few months, multi-family starts has tanked while single-family starts have continued to rise.
As long as millenials start to buy starter houses, the growth in single-family units should continue. So going forward, single-family starts will be much more important than multi-family starts for the U.S. housing market.
U.S. private sector employment growth has slowed down since 2015. This should not concern investors. As we explained in a previous post, employment growth always slows down a few years before the economic expansion ends.
Here’s are 2 simple examples:
- Employment growth slowed down long before the bull market topped in 2000. Private jobs growth was 3212k in 1997, 2734k in 1998, 2718k in 1999, and 1687k in 2000.
- Employment growth also slowed down before the bull market topped in 2005. Private jobs growth was 2328k in 2005, 1883k in 2006, and 859k in 2007.
Here’s the chart.
Auto sales are big ticket items. Conventional thinking states that falling auto sales is an early warning sign for recessions. This is not true. Falling auto sales is a very poor timing indicator for recessions and bear markets. Auto sales can fall for years before an economic recession or bear market in stocks begins.
Here’s the chart for light weight vehicle sales.
Retail sales growth fell last month, even if you exclude auto sales or gasoline sales. (The dollar value of gas sales falls when gas prices fall). But just like auto sales, retail sales growth can fall for years before a recession begins. Here’s the chart for Retail Sales ex-gasoline.
Sometimes Retail Sales growth will fall towards the end of an economic expansion, and then suddenly pick up at the last minute. That happened in 1999.
The ISM PMI has dipped a little over the past 3 months. This is simply a normal pullback after ISM soared from late-2016 to early-2017.
Over the past 7 years, U.S. economic data has always deteriorated a little in the summer months (May-August). Perhaps this is just seasonality weakness.
The recent weakness in U.S. economic data is most likely transitory. It should pass in the next few months.
Our medium-long term model states that this bull market and economic expansion have at least 1-2 years left (2 years is more likely).