Courtesy of Doug Short.
Note from dshort: The CFNAI is one of my favorite monthly economic snapshots, for which I provide an quick overview shortly after its released and a drill-down on the four major subcomponents a few hours later. Today Lance Roberts offers a deeper perspective on this indicator.
There has been much “hope” by mainstream economists that the slowdown in economic growth in the first quarter of this year was simply due to the blast of inclement weather that shuttered production in much of the North East. While the “weather story” most certainly had a negative impact on economic growth in the short term, there is not much evidence that an economic revival is in the offing.
I have written several times in the past about the most overlooked economic indicator – the Chicago Fed National Activity Index (CFNAI). This index is a broad composite of 85 subcomponents that provide a broad overview of activity in the domestic economy from consumption to production. The most recent release of the CFNAI for March showed a rather steep decline in national activity to .20 from .53 in February. That decline was driven by a steep fall in Sales, Orders and Inventories from .08 in February to a negative .02, and a decline in Production and Incomes from .54 to .21 in March. The drop in these two specific indices does not bode well for continued increases in areas such as employment, hours and personal consumption which are primarily lagging indicators relative to actual activity.
The “hope” of economic revival is not new. It has been the repeated mantra by mainstream economists and the Federal Reserve since the end of the financial crisis. However, as shown in the chart below, each economic bounce due to an inventory restocking cycle has been short lived with economic growth languishing at sub-par rates.
As I said above, the cold winter blasts of snow and ice that shuttered in much of the North East during the beginning of 2014 certainly had a short-term negative impact on economic growth. Therefore, it is not surprising that we have seen an uptick in activity in recent economic reports as companies once again restock inventories and some “pent up” demand flows through the economy. However, like we have seen repeatedly before, that surge in activity is likely not sustainable as the underpinnings of economic stability remain vacant.
This is clearly visible in the diffusion index of the CFNAI report. Each bounce in economic activity has led to a deterioration in the index. This has been prevalent throughout history and is indicative of a latter stage economic cycle.
However, to put this into perspective with more of the mainstream economic data I have compiled a comparison chart of the four subcategories of the CFNAI index.
Notice the sharp decline in housing starts. Housing has been touted as a key driver to economic growth in 2014. However, rising mortgage rates, as I have stated many times in the past, quickly killed demand from cash-strapped buyers and “buy-to-rent” speculators.
“The rising risk to the housing recovery story lies in the Fed’s ability to continue to keep interest rates suppressed. It is important to remember that individuals “buy payments” rather than houses. With each tick higher in mortgage rates so goes the monthly mortgage payment. With wages remaining suppressed, 1 out of 3 Americans no longer counted as part of the work force, or drawing on a Federal subsidy, the pool of potential buyers remains constrained.”
Also, note that Personal Consumption Expenditures continues to wane as well since peaking in 2011. With wage growth primarily stagnant, it is hard to increase consumption which makes up roughly 70% of economic growth. In a recent National Association of Business Economics (NABE) survey:
“8 of 10 companies do not expect wages to increase over the next three years. The survey indicates that 80% of businesses see wage growth adjusted for inflation to rise between zero and 3%. Despite the flat wages, it would actually be an improvement over the last three years. From 2011 to 2013, private industry inflation adjusted earnings fell by 0.7%, according to the Bureau of Labor Statistics’ Employment Cost Index.”
Of course, continued weakness in demand will weigh on industrial production and employment leading to ongoing sub-par economic growth at best.
We can visualize the supply/demand equation by breaking the CFNAI into the components that contribute to supply and demand. The chart below is a 3-month moving average of both data sets.
As you see, the demand side (consumption, housing, sales, orders and inventories) has slowed sharply over the last couple of months while the supply related components (production, incomes, employment and hours) still remain elevated. The supply side always lags demand as companies “hope” that any slowdowns are temporary. It takes some time for businesses to make physical adjustments to changes in demand. If the demand side of the equation continues to remain sluggish we will likely see a drop in supply in the months ahead.
While the recent uptick in some of the monthly economic reports is encouraging, it is likely temporary in nature. Corporate earnings reports, while beating much lowered estimates, continues to show weak top line revenues. This is clearly indicative of weak consumer demand which will continue to weigh on employment, wage growth and overall economic activity.
With the economic recovery now almost six years into recovery it has become a “foot race” to the finish line. With asset prices at elevated levels in anticipation of an economic revival, the failure of such a resurgence could lead to a significant disappointment for investors. Of course, the next couple of months will tell us much as the Federal Reserve continues to peel away their support and markets begin to reprice to economic reality.
Originally posted at Lance’s blog: STA Wealth Management
© STA Wealth Management
