Weekly Economic Update: 01-09-23

Our economic updates are written once weekly by nVest Advisors CEO Jeremy Torgerson for the general education of the public, and as a way to provide transparency for our clients and sponsored-plan participants as to how we create and modify our investment models.

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At-a-Glance:

• US Production continues to slow
• Global Trade is slowing
• The Job Market stays strong for now

 

Happy New Year! There is not much economic activity that gets released over the Christmas and New Year’s holiday weeks, so we took a couple of weeks off from writing this update to wrap up our client and business activities for the year. 2023 is already well underway, and we continue to monitor the broader economy as the full effect of last year’s interest rate hikes finally begins to show up in the economic numbers.

US Business Conditions continue to slow.

The first is US Manufacturing PMI. (PMI stands for Purchasing Managers’ Index, which is a survey of the supply chain managers in manufacturing sectors of the economy, to gauge current business conditions. The survey is taken once monthly and the survey participants give their assessment for business variables like new orders, backorders, inventory levels, supply chain variables, employment, and more.

The index is structured so that a neutral (neither improving nor worsening) business condition for the month would be scored a 50. Anything above 50 indicates that the business conditions are improving, and anything below 50 indicates that things are getting worse for manufacturing companies.

December’s Manufacturing PMI continued the broad trend it’s been on all year, posting a PMI of 48.4. This was slightly below estimates of 48.5 and was the second month in a row for the score to fall below 50. Manufacturers are telling us that we have crossed the threshold from a “slowing growth” economy, and are now seeing an actual contraction of economic output. If this persists for long enough, the economy will be officially declared to be in recession.

Perspective always helps when looking at economic numbers. Without the benefit of a longer look into the past, can we say that numbers are good, just okay, bad, or really bad?

A longer look back at the same survey helps to put today’s economy into perspective. Here’s a 25-year look at the same survey:

The dotted line in the middle is the mean for the entire time period (meaning, at any given point in the last 25 years, the “middle of the road” for manufacturing conditions was about 54), but you can see the graph wiggles all over the place. To help make sense of it, we added a blue-shaded region to the graph that tells us the most common range for this survey. You can see there are times when the survey spikes way above that shaded area, and way below (and if you notice further, the large spikes above are almost always followed immediately by a sharp reversal and swing downward; one extreme typically precedes the other).

The last three major dips below normal for this index were the Dot-Com Bubble of 2000-2002, the Great Recession of 2007-2009, and the artificial decline created by the government lockdowns during the Covid-19 scare. All three were later declared recessions with a lot of financial hardship for businesses and families alike.

The current reading of 48.4 is at the very bottom of the “normal” range for this index, and as the top graph indicates, the trend continues downward.

That is the current state of affairs for manufacturing companies, but what about the service sectors of our economy? Are things different for companies who don’t have to manufacture, ship and deliver a physical product to their customers?

The second report that was released during the last two weeks tells us that story. The US Non-Manufacturing PMI was released last week and shows a massive decline in the business climate for service companies:

Analysts were expecting a score of 55 (pretty robust growth, but down from earlier in the year) for service companies in December, but instead, we got a surprise drop to 49.6. This is dramatically lower than the year-long trend, and also indicates an actual drop in business activity in this sector for the month.

And as with Manufacturing, a longer look back at the Services PMI gives us more insight:

Once again, we can see the dotted line that is the mean for this number (about 55), the shaded blue range where 90% of the numbers for this survey have fallen, and the outliers of the Dot-Com bubble, the Great Recession, and Covid shutdowns. What is noteworthy in this graph, however, is that the December figure of 49.6 drops this PMI survey out of even a typical range and into “seriously down” territory. I am personally concerned because December’s drop was so much of a deviation, that either we will see a corrective report with January’s survey, or this is indicating a serious decline in services in the United States.

What this means to you:

Although these surveys are not actual measurements of financial results like a company shareholder meeting will provide, they are significant because they give us insight into how being in business in these sectors feels right now to the people “in the trenches”, and that is important because our sentiment will often predict our behavior. If supply managers sense that the economy is slowing and that business prospects are beginning to deteriorate, companies will begin to slow down their own buying, hiring, and manufacturing, to weather out the coming recession. This becomes somewhat of a self-fulfilling prophesy: when we fear a recession is imminent, we can often bring it about by slowing down our spending.

Global Trade is slowing.

It’s not just the United States that is experiencing a sharp decline in business activity; the rest of the world is feeling it, too. One way we can make that determination is by looking at the trade balances between our country and our trading partners around the world.

It is no surprise that the United States imports more goods and services than it exports; the average American consumer is the wealthiest (and therefore most supplied person in the history of the world.  We buy far more than our country can make and deliver, so much of our purchases come from other countries, where the costs to manufacture is much lower and their products are much more favorably priced than many American-made goods.

This results in a trade deficit of, for the last 25 years, about $44 billion dollars every month. You can see that on this graph as the dotted line:

This graph is interesting because so much of it, even during economic recessions, has remained consistently in the variance range (the blue-shaded area). The Covid pandemic, however, caused a massive shift toward more imports to the U.S., as supply chains were disrupted and our inflationary pressures began in earnest (meaning, our products and services rapidly increased in price), so it was substantially cheaper to buy more products and services from outside the United States.

However, recently that trend has reversed as the rest of the world now struggles with the same inflationary pressures we started seeing in late 2020. The December number surprised analysts by dropping back to only a $61.5 billion trade deficit after being nearly $79 billion the month before.

We believe this is further evidence of the economy of the United States declining rapidly. After seeing our own manufacturing and service sectors (the products and services made here in the U.S.) drop sharply last month in the previous section of this economic update, another surprise drop in imports to the United States indicates that American consumers aren’t spending any more money than they have to, and it doesn’t matter where the products are being made.

What this means to you:

Both the PMI reports and this trade imbalance show us a substantial drop in economic activity from the consumers of the United States. And, because more than 70% of our entire economy depends on you and me spending our pay to keep things moving, this indicates not only an imminent recession for the United States but also for many of the countries from which we import.

The Jobs Market stays strong for now.

Recessions take a long time to work out of the economy, and if one is indeed forthcoming, you can expect conditions to worsen further in the very next few months. This will eventually include, sadly, cuts in labor at many companies as their sales slow down.

The loss of jobs, however, is often one of the last things we typically see in a recession, because it takes so much effort and expense to re-hire and train new employees once the storm has passed and companies begin to increase their business again. We will typically see hiring freezes, cut hours, and furloughs before we will see mass layoffs.

We will be able to monitor the job market in a variety of ways, including company announcements of coming labor changes, a reduction in the number of open positions listed, economic surveys of the total number of workers at each company (this is done weekly), and finally, reports from the states of their total unemployment figures.

Many of the actual layoffs will be reported to us in a delayed fashion, because many workers will receive severance pay as part of their separations, and so will not file for unemployment benefits in their home states until those are exhausted.

So, what we would expect to see at this point in the economic slowdown, particularly after all of the hiring challenges companies faced after the Covid pandemic, is hiring and wage freezes, and perhaps a drop in the total number of hours worked per employee. We will also hear of some layoffs, but companies still struggling to be fully staffed will first re-hire as many of those laid-off employees as they can, delaying and muting the current state of employment.

And indeed, the reports from the states (the last link in the chain of reports about unemployment) seems to show that workers are not yet seeking significantly more unemployment benefits, as the US unemployment rate actually dropped in December, to 3.5%:

There is much cynicism in economic circles about this number, however, because this rate is fairly easy to manipulate for political purposes by simply changing the total number of people who are deemed to be “looking for work” (called the Participation Rate). At nVest Advisors, we are staunchly apolitical in our investment management philosophy (your IRA doesn’t care who the President is), but we are mindful of the general distrust of this number in academic circles.

That said, we do not see a significant change in the unemployment rates at this time. Nor should we; layoffs are the last part of the labor reduction we see in recessionary periods. What we would see first are reductions in job openings and new jobs created, which we are now starting to see:

The total number of jobs created in the U.S. in December (non-farm) was 223,000, a downward trend that has continued all year. This makes sense because the number of job listings, while still over 10 million currently, is also declining.

We believe part of this trend is a simple reversion to the mean, considering what the job openings in the United States have historically been trending over the last 25 years:

The Covid pandemic came with massive government subsidies to American companies: over $6 trillion (that’s $6,000,000,000,000) was freshly printed and given away to businesses and consumers to help keep the economy afloat. This not only caused the massive inflation in prices we are living with today, but it also caused many companies to make aggressive expansion plans with that added stimulus money. A massive hiring spree began in late 2020, but it was met with a sharp drop in available workers post-Covid.

Now that those days are over, we believe we will first see many job openings simply drop off, which will be followed by actual job cuts due to the economic slow-down we believe will be in full force by the middle of this year.

However, the good news – for now – is that the excess jobs have to be eliminated first before the job cuts can begin. Also, with the Baby Boomer generation retiring now at more than 10,000 per day, the demand for workers will likely remain stronger than previous recessions would indicate.

No one wants to see a business fail, or a family struggle to make ends meet due to the loss of an income. However, this sadly is the natural end result of the economic cycle we find ourselves in. If your family meets this unfortunate circumstance, please reach out to us for help.

Bottom Line:

We hope these economic updates have been making the case for our clients that we need to prepare to endure a recessionary year in 2023. No one knows exactly when a recession will occur, or how long and painful one may be, but we do have most of the indications that we are right at the starting point now.

Whether you are our client or not, you need to consider the broader economy (and much less so the daily market fluctuations) when making investment decisions. The economy is telling us clearly what is coming, and you need to have your investment accounts prepared before that happens.

Use these economic reports, and those of others working in this space, to prepare. You can not only avoid much of the pain that is coming, but you might actually profit from it, if your investments are properly positioned, and you’ve done what you can to shore up your business’ and family’s financial situation. If you need help with this, nVest Advisors has amazingly affordable personal financial planning and fiduciary investment management services to help you.

This is what we do for a living, and we’re very happy to partner with you on that endeavor.

Reach out to us for a totally free financial and portfolio checkup today if you’re concerned about where your finances sit for the coming few years, particularly if you are at or approaching retirement age. We’re delighted to offer you our thoughts. You can schedule that time with us below:

Watching This Week:

• Thursday, we will get updated news on the current inflation rate in the U.S.
• Friday, we will learn the new consumer sentiment numbers from the University of Michigan.

The views and opinions expressed in this economic outlook are for information purposes only and are not intended to be financial advice. nVest Advisors, LLC does not provide specific investment or financial planning advice to a client without an executed client service agreement. nVest Advisors, LLC does not trade directly in commodities or cryptocurrencies. Economic data changes rapidly; no warranty is expressed or implied about the reliability of this data once published. Although the information provided here is derived from authoritative sources, we cannot guarantee the accuracy of this information. Please see our general disclosure page for additional details.