A quick note today, based on a slightly more pessimistic frame of mind.
Over the last week or so, I’ve noticed a slightly worrying undertone emerging in some macro analyses – that the US might not be as strong as well think and that inventories are building. Barclays for instance last week produced a note last week that headlined with the following observation: the banks own proprietary global manufacturing index ” softened for the second consecutive month in February after reaching a multi-year highest level (0.81) in December 2017. The sentiment was mixed across the major economies, with the US ISM index printing significantly above expectations while euro area, the UK and China indices all demonstrated negative dynamics. The overall manufacturing sentiment remained elevated from a historical perspective in February.” Crucially Barclays noted that “at the subcomponent level, global new orders declined in February to 0.61 (-0.5 pts) while inventories strengthened further, reaching 0.66 (+0.13 pts). New orders less finished goods inventories, a forward-looking indicator, declined significantly to 0.15 (-0.17 pts). New export orders dynamics remained positive (0.77, +0.07 pts) reflecting favourable external demand conditions while cost-pressure dynamics remained muted with Input and Output prices remaining broadly unchanged.”
Then this week I saw this note from analysts at Liberum – their in-house early cycle indicator (ECI) has in the past flagged a major US industrial recovery in January 2016 but currently, it’s showing a ” red flag for the end of the cycle or at least a mid-cycle slowdown. Bottlenecks are causing companies to buffer inventories and will lead to sales slowing and costs increasing. Liberum is not attempting to predict, nor call a recession, however, based on 50 years of data, on each of the last six occasions when US inventories increased to above 55, on average US new orders to inventories ratio’s fell below 1.00 within six months – indicative of an industrial recession. Orders were above sixty for the 15th month; over the last fifty years, US orders have remained above 60 for an average of 10 months, with 17 months being the longest period in 2003-04.” According to Liberum this ECI measure indicates that we could about to see earning per share downgrades.
According to the UK investment bank “Liberum’s ECI has fallen to 1.13% – a further two months of data like this would support 4% organic sales growth from the second half of 2018 vs 5% consensus and imply earnings per share (EPS) downgrades for a sector close to record valuation levels. In addition to US weakness, a further warning signal came from China. Over the past five months, Chinese orders have fallen at the fastest pace since the first half of 2011 and the first half of 2012, which presaged a slowdown in Chinese GDP growth from 10% and 8% respectively. Europe fell from high levels but remains robust.”
Liberums ECI indicator
So, given these slightly concerning observations, let me paint a nightmare scenario. The US must be close to late cycle and thus starts to slow down. The US Fed pushes interest rates too high, too quickly. The US also trips into a trade war with China, while the ECB also starts to pull back its bond-buying activities so it can arrest the appreciation of the Euro. US T bond yields on 10 years go above first 3% and then 3.5%. All hell breaks out in the stockmarkets as investors start to panic. They move from worrying about inflation to the panicking about a slowdown.
On balance I don’t think this scenario is likely neither do I think its completely far-fetched. On balance I’d give it a 20% probability but that number has been rising for the last few months.