Has the U.S. Economy Really Comeback or Weakened? What’s the Outlook for 2020?

By the Curmudgeon with Victor Sperandeo

Introduction:

President Donald Trump will use next week’s State of the Union to promote what he calls the “Great American comeback,” according to a senior administration official. The Curmudgeon asks: What comeback?

President Trump has maintained an enthusiastic bullishness even though the annual GDP growth rate has fallen decidedly short of his promises of 3 or 4 percent. In January, at the World Economic Forum in Davos, Switzerland, Trump declared that “the United States is in the midst of an economic boom the likes of which the world has never seen before.” Really?

Overview of U.S. Economy:

Let’s look at a few data points which conclusively show the U.S. economy has been slowing and that is likely to continue:

· BEA reported this Thursday, January 30^th that U.S. GDP grew only 2.33% in 2019, which was down from 2.93% in 2018 and the same as in 2017. The U.S. economy has not expanded by 3 percent or more in a full calendar year since 2005.

· GDP growth during the fourth quarter of 2019 was 2.05849% (continuously compounded annual rate), slightly lower than the (revised) 2.08169% during Q3-2019.

· Gross private domestic investment fell 6.1% in the quarter, the third straight decline and significantly worse than the 1% dip in the previous period.

· Investment in structures slumped 10.1% and equipment, particularly on the industrial side, declined 2.9%.

· The major contributor to Q4 GDP "growth" was the unusually large decline in imports (GDP accounting subtracts spending on anything coming from overseas). While exports were marginally higher (1.4%), the BEA figures that the total dollar value of imported goods and services, adjusted for inflation, fell by an annual rate of near 9%.

· Imports were down sharply because of trade wars and the domestic part of the supply chain is near its breaking point.

· Inventories have been increasing (see chart below). If retailers and wholesalers are thinking of economic weakness and then see it confirmed by inventory piling up, they're going to begin cutting back on production and materials they order, which results in lower demand for imported goods as well as those produced domestically.

· The yield curve has inverted again. The spread between 3-month U.S. Treasury bill and 10-year U.S. Treasury note inverted on Thursday for the first time since October 2019. As of Friday, the 3 month T bill yielded 1.57% while the 10 year T note yield was at 1.51% according to a U.S. Treasury web site.

· The yield curve has flattened toward zero all month: Short-term rates have stayed steady with the Federal Reserve’s “on hold” monetary policy (and buying T bills to liquefy the repo market), while longer-term yields have tumbled amid mounting evidence that the deadly coronavirus is harming the outlook for global economic growth. Why is that significant? Because the yield curve inverted prior to each of the past seven recessions. It’s such a reliable indicator, that both the New York Fed and the Cleveland Fed calculate the probability of a downturn in the coming 12 months based on the slope of the yield curve!

· Similar concerns about the global economy’s health have also showed up in commodity markets, including industrial metals. This month, March futures for copper have fallen nearly 10% to $2.527 a pound, and March West Texas Intermediate crude futures are down more than 14% to $52.11 a barrel on the New York Mercantile Exchange.

· Finally, no new legislation has or will come out of the U.S. Congress as a result of the impeachment proceedings and bipartisan deadlock. That means the U.S. government hasn’t and will not likely do anything to stimulate economic growth.

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Comments from Economists and Business Professionals:

“Underneath what you’re seeing is slower domestic activity,” said Kathy Bostjancic, chief United States financial economist at Oxford Economics. “It’s just the natural state of things.” Thursday’s GDP report shows that trend is continuing. “We’re seeing some loss of economic momentum as we exit 2019 and come into this year,” Ms. Bostjancic added.

“There is no evidence of broader positive developments (related to the decline in U.S. imports),” said Brad W. Setser, a senior fellow in international economics at the Council on Foreign Relations. “To the extent that tariffs have succeeded in bringing the trade deficit down, they have done so largely by reducing U.S. demand, not by raising U.S. production.”

Ben Herzon, executive director of United States economics at Macroeconomic Advisers, a forecasting firm said that research shows that the “level of investment spending recently has been about $100 billion lower than it would have had there been no uncertainty about trade policy.” That uncertainty is likely to continue – not only with China, but with Europe too.

"The behavior of the U.S. Treasury yield curve since September is a little bit disturbing in that we've had monetary stimulus come in," said Ed Al-Hussainy, senior interest rate and currency analyst for Columbia Threadneedle Investments. "Despite all of this, 10-year yields basically never got above 2% since September.”

“The flattening of the curve is an indication that the growth concerns are greater now,” said Marvin Loh, senior global macro strategist for State Street bank. “Everything is just a bit more fragile, and we’re all wondering what the next headline is around the coronavirus.”

"Consumer sentiment is terrific and the market is terrific, but all the surveys of CEOs say they expect a decline in the economy and I think, 'Who's got a better feel for that?'" said Peter Ricchiuti, a business professor at Tulane University who regularly speaks with small- to medium-cap company CEOs.

“The coronavirus certainly presents a headwind to the reflation of global growth story, which investors were anticipating into this year,” Charlie Ripley, senior investment strategist at Allianz Investment Management, told MarketWatch.

John Williams of ShadowStats wrote in a note to clients:

As Headline Economic Reporting Increasingly Shows Slowing Economic Growth in Key Data, Looming Benchmark Revisions Promise Downside Revisions to Recent Economic History. Discussed in Special Commentary No. 985, headline economic reporting of the last year was skewed heavily, likely to the upside, as a result of incomplete and distorted reporting that resulted from the government shutdown.

Despite headline December 2019 U.3 unemployment hitting a 50-year low of 3.50% at the second decimal point, annual payroll growth slowed to a two-year low at the same time, in advance of what should be negative annual benchmark revisions to payroll employment on February 7th [see Flash Update No. 18]. In terms of harder economic numbers, consider that Fourth-Quarter 2019 Real Retail Sales and Real Earnings, Industrial Production, Real New Orders for Durable Goods and the smoothed CASSTM Freight Index all contracted quarter-to-quarter, with total full-year annual activity in Manufacturing, Real Orders and Freight actually declining from the levels of full-year annual activity in 2018. December 2019 domestic freight activity plunged year-to-year in a manner and by an amount not seen since the onset of the Great Recession.

Victor’s Comments on the Markets:

The financial and commodity markets were greatly affected by the unexpected corona virus. Stocks, till the last day of January, pretty much ignored the virus because it is weighted towards the tech stocks which everyone loves. When the World Health Organization (WHO) declared “a public health emergency of international concern,” the stock market started to take notice.

Commodities perceived the virus as a “black swan” killer event. The decline was particularly devastating due to the tremendous hype surrounding the U.S. - China trade deal. The markets were led to believe that China would be a buyer of U.S. grains, (perhaps) oil, copper, and many other world commodities. As China buys a huge percentage of most commodities, the country being closed for business (to prevent this virus from spreading) caused across the board declines in commodities, even as most trends were up in January.

Whenever you have a transition in trends across the board it is always bad. The fear surrounding the corona virus also caused downtrends to reverse, e.g. U.S. bonds/note prices were heading lower then rallied. To a lesser degree, the Japanese Yen also reversed to the upside as a “safe haven” currency.

This virus is extremely contagious so until the number of people start to be infected less, “risk-on” markets should be down to flat. It should be noted that June Gold closed at a 5 year high on a so called “flight to safety.”

The Democratic primaries will be important to watch. By March 3^rd (Super Tuesday) the remaining candidates should be Sanders, Biden, and Bloomberg (the Curmudgeon’s favorite). Should Sanders or Warren be Presidential contenders the markets will be very nervous. As much as many people don’t like Trump most like his polices. The same cannot be said for Sanders or Warren who are perceived by many as Socialists.

Some final thoughts: 

• The U.S. dollar should decline as the rout in commodities will cause inflation to decline. As disinflation or deflation occurs in the U.S. the Fed will lower rates which will lower the dollar on world currency markets. 
• The whole world will follow the Fed as without China buying goods and commodities, deflation is in the cards.
• Debt instruments should continue to rally in price, while yields decline.
• More stimulus will be forthcoming by global central banks. This in part as Brexit finally happened to a degree. It's not official in my world for another 11 months till its final. 

Victor’s Conclusions:

1. The Fed reducing its balance sheet too fast is totally responsible for the U.S. economic slowdown, in my opinion. That’s even though the Fed started to greatly increase its balance sheet last September to add liquidity to the repo market [1.].

Note 1. The repo market is where high-quality securities are swapped daily for trillions of dollars of cash, making a wide range of transactions easier.

2. President Donald Trump exaggerates almost everything so the economy will never grow at 3% as long as Jay Powell is head of the Fed. I have to say that Trump needs to return to school as he has no idea who he is hiring and what they stand for? His “ HR” instinct gets a grade of F- for what he wishes his agenda to be.

Closing Quotes:

As we enter the important U.S. presidential election season in March, perhaps the words of some former leaders are apropos.

Otto Von Bismarck (1815-1898) said: “People never lie so much as before an election, during a war, or after a hunt.”

Or as observed by Deng Xiaoping: “The United States brags about its political system, but the President says one thing during the election, something else when he takes office, something else at midterm, and something else when he leaves.”

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Good luck and till next time….

The Curmudgeon
ajwdct@gmail.com

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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