The overall pessimism about the US economy has not subsided as nominal GDP growth has been less than three percent, Q4-over-Q4 , and in that kind of world, corporate profits don’t grow very much, said Joe Lavorgna, chief US economist at Deutsche Bank.
People are focused on the labor market, which is a backward looking indicator; companies hired people, but unfortunately as they did that, the bottom dropped out so to speak, especially in manufacturing. It’s likely things will continue to slow, he noted.
The latest retail sales and unemployment reading came in stronger than anticipated. Asked to comment, Joe said retail sales numbers for the past three months are up three percent annualized, which is not a good number, especially given how low energy costs are and how much job growth the economy had.
While retail sales are not declining, historically there were plenty of downturns where sales were positive. Consumers need not be negative for the economy to go into a recession or equities to fall 30 percent, he observed.
Many people say to gauge a true recession investors should watch consumer spending since consumption contributes two-thirds of US GDP. Asked to explain, Joe said the belief that consumption is the best indicator of the economy is patently wrong and investors should look at history.
Consumption doesn’t move a whole lot within the economy; what drives a business cycle is typically the investment side – capital spending and inventories, that’s what drives the cycles mostly. The US economy is witnessing a big deep downturn like they did in 2008-09 when everything collapsed. But in the 2001 and in the 1990-91 recessions, consumer spending was positive. The notion that spending has to be negative (for a recession) is a complete falsehood, he argued.
Telecom equipment maker CISCO’s CEO said recently he’s witnessing some concerns about new orders among its clients, which mirrors DB’s concern about a pull-back. Asked to comment, Joe said while the US economy might not be headed to a recession, the probability remains much higher than most people believe.
When an economy grows as feebly as it has been, as long in the business cycle as has been, and is driven by just one sector – the consumer – it gets more prone to get hit by some negative exogenous shock; whatever that may be remains to be seen.
Maybe it would be China, or may be it would be further dollar appreciation. The economy is at that point of the cycle where one has to be extraordinarily cautious and defensive, he noted.
DB’s view contrasts with Goldman Sachs’ as the investment bank says now is the time to short gold and there could be three rate hikes from the Fed this year and stock markets could climb 12-13 percent from here.
The bears can cite a multitude of variables to augment their case, but the fact of the matter remains that M&A activity has remained very robust, despite declining year-over-year, said Richard Peterson, Sr. director at S&P Capital IQ. The US is a service-driven economy; while manufacturing might have been hit by the downturn in oil prices, it’s likely to be short-lived and at one point there could be a recovery at the back-end of 2016 or perhaps in 2017, he observed.
Asked if DB’s gloomy forecast has been baked into the markets, Joe answered in negative. The high-yield credit spreads have typically led in the last three downturns and they are at levels in the past where there were recessions. If investors look at market price signals – whether materials or high-yield spreads or sectors within equity – broadly speaking consumer discretionary or financials, or even the slope of the yield curve, every single market indicates there’s a growth problem.
If investors become data dependent – whatever that means, by the time the data confirms a slowdown, the equity market may have bottomed and is already recovering despite the data being soft, he concluded.
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