Albert Edwards: "Has The US Recession Already Begun?"
Some are surprised that inflation has failed to take off despite massive amounts of quantitative easing. The explanation, ECRI explains, is simple: recession kills inflation. For all the talk of the wealth effect, demand is falling and deflation is closer than at any time since 2009. The 'r' word is seldom heard on the lips of the mainstream media - how absurd - but as SocGen's Albert Edwards notes, if anyone is waiting for the ISM to tell them that a recession has started in the US, they are looking at the wrong data. Much more importantly, Edwards explains, we may well be in for a double dose of bad news - both falling revenues and falling margins. History suggests this as good a leading indicator as any other for whether the US economy will endogenously fall back into recession.
Via SocGen's Albert Edwards:
One of the axioms of economics I have always had a great deal of faith in is that profit margins mean revert.
But unfortunately at the height of a recovery most commentators forget this as they become intoxicated by the equity market's prior stellar performance and tend to continue to price the market off analysts' forward earnings - which inevitably always forecast further healthy gains ahead. Even the use of trailing earnings for PE calculations tends, in retrospect, to be too optimistic. That is why cyclically adjusted PEs are so important.
excluding financials, profit margins have failed to break out above their usual range. As night follows day, the market should be pricing in a decline in the margin cycle from here.
The surprisingly weak out-turn in May for the US manufacturing ISM seems to me just a continuation of what we have seen for the last few years, with mini-cycles of optimism and pessimism anchored to a clear downtrend
It is also notable that just as the last recession was starting in November 2007, the ISM was embarking on a surprising six month long H1 2008 recovery back above the key 50.0 mark, before plunging in August and September ahead of the Lehman bankruptcy... The bottom line here is that if anyone is waiting for the ISM to tell them a recession has started in the US they may be looking at the wrong data.
We find profits data far more useful to determine if a recession has started or indeed about to start. The results are 'shocking':
"In the S&P 500, there have been 91 negative EPS preannouncements issued by corporations for Q2 2013 compared to 13 positive EPS preannouncements. By dividing 91 by 13, one arrives at an N/P ratio of 7.0 for the S&P 500 Index. This 7.0 ratio is higher than the N/P ratio at the same point in time in Q2 12 (3.4), and is above the long-term aggregate (since 1995) N/P ratio for the S&P 500 (2.4)."
Reuters goes on to say that if this persists it would be a record pace of downgrading ahead of a reporting round.
In addition to the margin downturn, revenue growth is also flagging badly. Thomson Reuters also reports that revenue forecasts are being missed at an increasingly rapid rate. Indeed, the latest slide in the ISM below 50 suggests we are now close to outright yoy decline
Thus we may well be in for a double dose of bad news - both falling revenues and falling margins. History suggests this as good a leading indicator as any other for whether the US economy will endogenously fall back into recession.
AS ECRI confirms:
Despite surging prices for homes and equities, consumer spending is contracting, registering its biggest monthly decline since September 2009. Quite simply, the wealth effect is rendered moot by languishing incomes.
No wonder yoy U.S. import growth has also plunged into negative territory, whether or not oil imports are included. In recent decades, this has happened only during U.S. recessions. Notably, unlike data for GDP and jobs, imports data are not revised substantially, long after the fact.
As a result, core inflation – defined as yoy growth in the Personal Consumption Expenditure (PCE) deflator excluding food and energy – has now dropped under 1.1%, to the lowest reading in its entire 53-year record.
Meanwhile, yoy growth in the headline PCE deflator has dropped to 0.7%, its lowest reading since October 2009, and far below the Fed's official 2.0% target. This inflation measure has never been this low except during or in the immediate aftermath of recession.
The bottom line: for all the talk of the wealth effect, demand is falling and deflation is closer than at any time since 2009.