2019 has seen a marked deterioration in the Astor Economic Index® (the AEI) from levels we associate with strong growth to levels which we see as more representative of average growth. This long-term chart of the AEI shows that while not unprecedented, the sharp decline in the AEI over the last few months is unusual.
It’s important to recall that we do not see the AEI as a forecasting tool, it’s more of a “nowcasting” tool – we use a systematic analysis of various employment and output series to say where the economy is today, and today’s growth seems to be moderating. It is equally important to point out that although we see growth moderating, we do not see the economy contracting.
Today, the growth rate looks to be somewhat lower than what we have enjoyed in the last 10 years since the end of the recession associated with the global financial crisis. The causes of this slowdown are not entirely clear (disruption to the global value chain through increased U.S. protectionism is one likely culprit), however, I believe that the underlying slowing has been evident for some time. For example, I think we can see it in the lack of boom last year as massive stimulus when already near full employment seemed to have little discernable effect on investment or employment and only a transitory boost in output.
Is our AEI an outlier? It doesn’t seem like it. We can look at the regional federal reserve banks’ nowcast estimates as another attempt to see where the economy is today. The New York Fed is currently nowcasting an estimate of 1.4% Q2 growth. Similarly, the Atlanta Fed’s model is showing Q2 growth of about 1.6%, both below the potential growth rate.
When we look at representative economic series we don’t see any one series diving off a cliff, although we do see several series returning to long run average rates at the same time. For example, the upper panel in the chart below shows a smoothed change in net new jobs since 2010, and the bottom panel shows the ISM manufacturing purchasing manager index over the same period. Both are somewhat below average, but neither is flashing recession signals.
However, just as the risk of the flu is greater to those with compromised immune systems, surely the risk of falling into a recession is higher the more modest the pace of economic activity at the outset.
At Astor, we use an economic lens on investing. That is, we think the markets quickly adapt to current levels of economic activity and that usually average growth is associated with average returns and so should lead to average allocations to stocks. Hence, our portfolio moves this year: Astor Dynamic Allocation began the year with close to maximum levels of equity exposure and after reducing steadily we are about average. Our judgement is that the risk of the market due to a mediocre macro environment is such that only an average equity position is justified. Should the economy regain faster growth, we will be happy to increase equity exposure accordingly. Conversely, should the economic situation as we measure it continue to deteriorate, we stand ready to further cut equity exposure.
Trade represents a mainly downside risk in my view. The realistic best case is a quick, comprehensive trade deal with China but that would get us officially back to where we started but my guess is that the market has already priced in a deal of some sort. In addition, domestic political pressures seem to be constraining both the Chinese and American sides. Thus, I see little hope of a sustained trade-based rally.
On the other hand, new trade frictions and a modest rollback of globalization could cause short and long term worries for the stock market. As I noted the day after the election, Congress has delegated a great deal of discretion to the president when it comes to trade. With a hammer close to hand, every problem looks like a nail to this administration and it has been threatening additional trade wars against Mexico and the European Union. Should these move beyond the boasting stage to tariffs an already slow global economy could take another hit. In addition, companies have begun to change their behavior on the judgement that the decades-long international integration of value chains will stagnate somewhat. We can see this in reduced levels of trade and slower cross-country investment globally. The trade tensions have thrown sand in the gears of the world economy and no one seems to want to clean them out again.
Will the Fed’s well-telegraphed rate cuts be enough to significantly boost the economy?
It seems unlikely to me. The Fed has been hinting at a small cut in rates, not a full-fledged easing cycle and more quantitative easing is not being discussed. The Fed has been talking about insurance cuts and making its inflation target, not about the economy deteriorating and needing support. We will learn a bit more (though not as much to make anyone satisfied) at the end of July when the FOMC meets but the modest easing in the offing seem unlikely to inflame capitalist passions.
For still more charts you can see our weekly collection of economic charts or download the Astor Economic Research App from the App Store. As always, we at Astor will be monitoring the economy closely to inform our investment decisions.
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The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.