The US—the world’s biggest economy and the largest constituent country in the MSCI World Index of global developed stock markets—released a spate of economic data this week, giving those on recession alert much to chew over.[i] The report on May consumer spending received most attention from commentators we follow, as it showed household consumption falling -0.4% m/m once adjusted for inflation (or on a “real” basis, to use the technical term).[ii] Given US gross domestic product (GDP, a government-produced measure of economic output) is about 70% consumer spending, its drop prompted many commentators to warn recession is imminent, if not underway already.[iii] Yet in our view, a broader look at the latest data suggests things aren’t uniformly negative in America’s economy, which could create substantial room for positive surprise to boost stocks. What did financial commentators we follow seemingly overlook in the latest data? Read on!
Durable Goods Orders Look Pretty Durable
The week started with May’s advance durable goods report, released Monday. It showed total orders for goods designed to last three years or more rising 0.7% m/m, beating analysts’ consensus expectations for no change and accelerating from April’s 0.4% climb.[iv] Core capital goods orders (non-defence capital goods orders excluding aircraft), which are widely considered a proxy for business investment, grew 0.5% m/m—their third straight rise and an acceleration from April’s 0.3%.[v] Now, this corresponds only to the equipment portion of business investment, which is only about 40% of the total in America—commercial real estate and intellectual property products (e.g., research & development and software) hold a large influence, too.[vi] And these figures aren’t adjusted for inflation (broadly rising prices across the economy), which is an important caveat. But we think the resilience of a major category is still noteworthy, as it occurred against the backdrop of rising interest rates—a factor financial commentators we follow have warned would derail investment for months.
Those worries always struck us as overwrought. To date, America’s prime loan rate—one of several base rates used by banks to price short-term business loans—is up 1.5 percentage points this year.[vii] In our view, if an investment in capital equipment’s long-term return would be destroyed by that small an increase to borrowing costs, then common sense suggests to us it likely wasn’t a wise investment to begin with—and probably wouldn’t have happened. Now the data are starting to bear this out. Also positive, in our view? We haven’t seen much evidence that the inventory cuts that dragged down Q1 GDP were the start of a longer cycle of businesses getting lean and mean.[viii] If it were, we would probably start seeing that here. Instead, the durable goods data suggest to us that businesses remain expansive, cutting against fears that a recession is underway already, in our view.[ix]
Taking Stock of InventoriesSpeaking of inventories, Tuesday brought news that wholesale inventories (the amount of goods stockpiled in wholesalers’ warehouses) jumped 2.0% m/m in May, adding to April’s 2.3% rise.[x] Retail inventories (the amount of goods on hand at retailers) also rose, up 1.1%.[xi] This might seem to indicate a turnaround in inventories’ contribution to GDP, which was a drag in Q1 as mentioned above. Yet monthly inventory measures were also positive throughout Q1, making their negative contribution a surprise.[xii] So we think it is premature to conclude that a rush to replenish stockpiles will boost Q2 GDP. (Here, too, take note: The data aren’t inflation-adjusted.)
At the same time, we see other potential interpretations—some positive, some negative. On the potentially negative side, for those who suspect companies are overstocked, a continued inventory rise could indicate a mounting overhang that will require deep discounts to clear later. This could theoretically weigh on production in the period ahead. But that is only one possibility—and perhaps a positive development in the eyes of some, to the extent discounting could help tame inflation, which would help quell a major issue weighing on markets this year. Or, for those who posited that rumours of overstocking were greatly unfounded and supply chain issues were still rearing their ugly heads, then positive inventory data could provide some relief by showing goods are still flowing from factories to vendors.
If you find this choose-your-own-adventure approach frustrating, we hear you—but we have found that comes with the territory when trying to analyse inventories. They are always open to interpretation, in our view. Rising inventories could indicate businesses racing to get ahead of expected demand—or they could indicate a building supply glut. Falling inventories could signal supply chain problems, businesses’ cutting bloat, or production not quite keeping pace with outsized demand. We think the answer is only ever clear in hindsight, which is why we don’t lean on inventories as a forward-looking indicator.
Preliminary Trade Data Don’t Suggest Recession, Either
Tuesday’s other big American release was the advance report on May trade, which showed exports rising 1.2% m/m and imports falling -0.1%.[xiii] Considering net trade (exports minus imports) detracted from Q1 GDP as exports fell and imports rose in that quarter, May’s report might seem good from a GDP-maths standpoint.[xiv] But it isn’t adjusted for inflation, and it includes trade in goods only. Broader data including trade in services will be more telling, but those won’t hit until 7 July.
Then again, we think GDP maths get it wrong, as they treat imports as a drag even though they represent domestic demand. Major retailers in America are well-known to import a large portion of their inventory. So if imports are down, that probably means these retailers have hit tough times. Therefore, in our view, the crucial question to ask is whether a slight slide in goods imports represents falling demand.
It might—but we see reasons to think otherwise. As you may have read, the dollar is at its strongest level in years versus major global currencies.[xv] That means every dollar spent abroad buys more than it used to. It is entirely possible that the US imported more stuff—a higher volume of goods—but spent slightly fewer dollars to do it thanks to the dollar’s strength. It is also possible that the stronger dollar offset inflation in other countries, keeping overall trade volumes flattish. The US, unlike Japan and the UK, doesn’t produce trade volume indexes—these gauges measure just the values—so we can only guess. But in a world where many commentators seem determined to find the cloud in every silver lining and couch every positive economic report as bad news, we think the mere existence of possible positive interpretations is an unsung good. In our view, it raises the probability that reality is better than feared, even if just modestly so.
As for whether these stronger-than-feared data put the US Federal Reserve on a more aggressive tightening path—as some commentators we follow have suggested—we won’t opine. In our experience, divining what the Federal Reserve may do beforehand is a futile exercise, one that would require knowing how they interpret all the incoming data. As shown, that is far from clear.
[i] Source: World Bank and FactSet, as of 1/7/2022. Statement based on nominal (current-dollar) GDP in US dollars and the market capitalisation of the MSCI World Index and its constituent countries. Market capitalisation is a measure of a company’s or stock market’s total value, calculated as share price times the number of shares outstanding.
[ii] Source: US Bureau of Economic Analysis (BEA), as of 30/6/2022.
[vii] Source: St. Louis Federal Reserve, as of 28/6/2022.
[viii] Source: US BEA, as of 30/6/2022.
[ix] Source: FactSet and S&P Global, as of 30/6/2022. Flash PMIs are preliminary estimates based on 85% - 90% of responses.
[x] Source: FactSet, as of 28/6/2022.
[xii] Source: FactSet, as of 1/7/2022.
[xiii] Source: US Census Bureau, as of 28/6/2022.
[xiv] Source: US BEA, as of 30/6/2022.
[xv] Source: FactSet, as of 28/6/2022.
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