Industrial Production on Verge of Recession
History warns that recent metrics foretell of an economic recession, yet we think this time is different.
When looking at Corporate GAAP Earnings, Global trade volumes, Weekly Leading Indicators and Industrial Production data we might normally warn that our economy is near recession territory. In such a case you would need to be mostly in cash and Treasuries and out of stocks. As you can observe in the first chart, when Industrial Production contracts at the recent rate it means a recession is close. The same relationship holds going back almost 100 years.
Weakest Earnings Pace Since The Great Recession
Having 4 quarters of year over year corporate earnings contraction is also very unusual without forecasting an economic recession.
Earnings Collapse Isolated to Energy & Related Sectors: Not Systemic Yet
So how can we ignore this solid evidence that the economy should be going from bad to worse? Is it really different this time?
Should Oil move back to new lows in the mid $20’s/barrel and the 2nd Quarter GDP fail to rebound from a dismal 1st Qtr (~0.6 to 1.4%?), then we will be quickly switching to a Bear market outlook and vastly reduced equity exposure. However, for many months we have expected oil prices to bottom in January/February and carry most markets higher into the 2nd quarter, especially the beaten down industrial segment. The decline in earnings and industrial production is due to a relatively severe recession only in the energy sector. The earnings distribution below hints that the extreme losses in energy companies have yet to cause alarm in the far larger service sector. More damage to energy related companies and junk bonds with new lows in Oil would be a concern, but for now our expected energy rally is on schedule and earnings should improve near term.
Regional Fed Branches Foretell Rebound in Manufacturing
Today’s report on the Purchasing Managers Index (PMI) survey rebounded sharply as we expected when Oil bottomed in February and after the 12 Federal Reserve branches all rebounded strongly earlier in March. The NY Empire branch had clearly fallen into a zone typical of recessions in January and February only to return back to expansion mode in March.
More impressive than the rebound in the Manufacturing Composite PMI is the fact that the PMI New Orders component soared to a 16 month high at 58.1. With low unemployment and a rebound in future order flow we would expect rising GDP forecasts as the 2nd quarter progresses.
Oil Was the True Leading Indicator
Last November we forecasted a final decline in Oil prices and the industrial economy continuing into early 2016 bottoming by the end of February. A further sign of our expected seasonal demand low was confirmed in the 1st quarter when Managed Money positions fell to their most negative oversold readings since the crash lows of 2009. This sentiment Buy signal and forecasted low in Oil should rally to a peak in the 2nd quarter with strong resistance in the $50 to $60 range throughout 2016 as excess inventory begins to stabilize longer term. As long as Oil and energy markets are recovering then earnings and stock prices will be firmer.
We expect the GDP to bottom in the 1st quarter of 2016 near 1% (+ or – 0.4%) and improving numbers back above 2% growth for the remainder of 2016. Should regional Fed data or Oil prices approach their January lows then we will confess our sins and quickly downshift our stock market exposure from 85% invested and prepare for a more systemic turbulence ahead.