- On Tuesday, the market was forced to digest the worst ISM manufacturing print in a decade.
- Meanwhile, the financial media is engaged in something of a disagreement with Peter Navarro over the veracity of reports that the US may restrict capital flows to China.
- For what it’s worth, a couple of sub-50 ISM manufacturing prints need not spell the end of the expansion.
- But we’re clearly on thin ice with the trade war.
Let me kick off what I expect will be a very straightforward post (by my standards anyway) by noting that despite Peter Navarro’s best efforts to downplay reports that the Trump administration is considering a variety of options to limit capital flows to China, those reports are not, as Peter suggested on CNBC Monday, “fake news” (his words).
I talked at length about the prospect of the US restricting access to Chinese markets in a Friday evening post for my readers here. Over the weekend, Steve Mnuchin’s Treasury told Bloomberg (who broke the story) that no move to restrict US listings by Chinese firms is imminent. Spokeswoman Monica Crowley did not, however, speak to the veracity of the other proposals Bloomberg said are under discussion.
On Monday, Navarro showed up on CNBC and called the Bloomberg story, quote, “fake news”. “It was really irresponsible journalism and the problem we have here [is that] these bad stories push out the good,” he went on to charge.
As you’ve probably heard by now, that “discussion” quickly devolved into a highly contentious exchange between Navarro and the network’s Kayla Tausche. Suffice to say that come Tuesday, Tausche had a point to prove.
First, she claimed to have seen an actual memo proving that the White House had, in fact, discussed the issue last week and intended to do so again this week. To wit, from her Twitter:
|NEW: White House circulated policy memo last week that started discussion process on potential US/Chinese investment limits. Today a source showed me the “Policy Coordinating Committee” memo, which includes Navarro’s office. It suggested a follow-up meeting this week to discuss.|
Later, Tausche brought up the discussion with Navarro again, tweeting the following about Tuesday’s abysmal ISM manufacturing print:
|Yesterday on @SquawkCNBC, I asked WH trade advisor Peter Navarro about weakening manufacturing data and job losses in Pennsylvania and Wisconsin. “I don’t even know why you’re going down this path” of questioning, Navarro said. “Manufacturing is strong as a rock.”|
Those tweets neatly encapsulate the two points I wanted to make for readers here on Tuesday.
First, the threat of the US restricting capital flows to China is real. The discussions have taken place. Period. CNBC has “seen the receipts,” so to speak, and as Navarro was reminded when he was on the air Monday, a half-dozen mainstream media outlets including Bloomberg, the New York Times, CNBC and Politico, have all reported some version of the same story. The entire interview with Peter is available from CNBC here.
Incidentally, Ray Dalio wrote an entire blog post on the subject Tuesday, for whatever that’s worth.
Second, the manufacturing sector in the US is rolling over. ISM printed a grievous 47.8 for September. That missed every estimate from 69 economists. The range was 48.2 to 52.
The optimists among you will doubtlessly point to the still resilient services sector and, relatedly, the US consumer, who carried the economy in the second quarter and continued to show up in August (when retail sales rose for a sixth consecutive month).
If that’s you (i.e., if you’re one of those optimists), you’re not wrong. I’ve repeatedly pointed to buoyant consumption and the still solid services sector as a reason to believe that the US economy is still several quarters from turning down in earnest (see top pane below). Really, that’s not so much me making a prediction as it is me stating the obvious (some pundits deliberately conflate those two things).
But, consumer confidence is flagging. September saw a slight rebound in University of Michigan sentiment, and we’re still sitting at elevated levels overall, but in the context of the Trump era, things are “not good, not good,” as the President would say. The bottom pane in the visual above puts recent consumer sentiment readings in the context of the collapsing ISM and a sharply decelerating 6-month average for nonfarm payrolls.
Note that we’re about to see “who” is telling the “truth”. Later this week, the market will get ISM non-manufacturing and September payrolls. Hopefully, those will both be beats, and we can persist in the idea that the US economy can weather a manufacturing slump without falling into a recession. If that’s the case, history suggests there’s quite a bit of upside for equities.
However, risk assets appear to be woefully detached from the manufacturing slowdown – at least on an admittedly superficial assessment.
For instance, high yield credit spreads are remarkably subdued compared to ISM.
Compare that to a simple chart of 10-year Treasury yields versus the widely-followed factory gauge:
Again, there’s nothing “scientific” or in any way novel about those two simple charts. Rather, the point is to illustrate the extent to which one risk asset (junk bonds) isn’t paying attention whatsoever to the flagging manufacturing sector, while benchmark US yields are doing exactly what they “should” be doing amid the burgeoning factory slump.
There are no shortage of analysts and commentators who will tell you that markets are far too sensitive to manufacturing misses considering the sector’s fading representation in the economy as a whole.
In a July note, for instance, Goldman observed that “manufacturing data such as the ISM and industrial production reports account for 25% to 45% of the bond market impact of activity data surprises.” As you can see from the following chart, those numbers are grossly disproportionate to manufacturing’s share of the real economy.
As Goldman went on to write in the same note, “Wall Street’s focus on manufacturing makes sense [because] manufacturing activity is more volatile than the rest of the economy [and] the sector still accounts for 37% of the S&P 500 market cap.” That’s the light blue bar in the middle.
However – and this is the crucial bit – the manufacturing sector simply doesn’t play a large role in explaining the variability in GDP and non-farm payrolls. As Goldman put it in July, “the contribution from manufacturing to GDP volatility has fallen from 60% in the early 70s to 20% now.”
So, perhaps there’s nothing to be alarmed about in Tuesday’s big data miss. And perhaps the selloff it occasioned is a buying opportunity.
But you should note that some seasoned veterans think that’s largely nonsense.
“If I had a Swiss franc for every time someone told me they were ignoring the manufacturing sector slowdown, just ahead of an economy collapsing into outright recession, I would be a rich man,” SocGen’s incorrigible bear Albert Edwards quipped over the summer. (Albert will forgive me for calling him a “seasoned veteran”.)
One thing we know with certainty is that the trade war is contributing to the global manufacturing downturn, which has now boomeranged, making landfall stateside. One sure way to escalate the trade conflict would be for the Trump administration to move ahead with a plan to restrict capital flows to China, even if that plan is designed to limit the market fallout.
Although it’s entirely possible that President Trump’s recent trials and tribulations inside the Beltway will compel the administration to strike a trade deal sooner rather than later in a bid to boost stocks and help buoy the economy, it’s also possible that the unfolding impeachment drama could have the opposite effect.
“Political pressure might increase the assertiveness of the President, which increases the risks of increased use of tariffs and unconventional tools to attain other policy goals (on currency, immigration etc.), and could bring a broadening and escalation of the trade wars,” Barclays cautioned on Sunday.
Fair warning, I suppose.
(Source: Seeking Alpha)