Tuesday, August 27, 2013

Sowing the seeds of recession

In the latest economic news, durable goods orders dropped 7.3 percent in July according to the Commerce Department, the steepest drop in nearly a year.  Contributing to the drop were fewer orders for commercial aircraft and weakened demand for computers and electrical equipment among businesses. 

The drop in durable goods orders is a definite sign that the business economy is losing momentum.  Yet the New Economy Index (NEI), which measures the overall state of the retail/consumer economy is still in fine shape.  Why then is there such a disparity between the manufacturing economy and the retail economy? 

Manufacturing typically slows before consumers start reigning in spending on discretionary items.  What we’re witnessing the beginnings of a slowing economy where the manufacturing sector will be the first to experience weakness.  Then a spillover effect will eventually make its way into the everyday economy of consumer spending.  It’s a slow, gradual process akin to a large tanker ship doing a turn at sea: it takes time for the forward momentum to reverse before the shift in direction can be made. 

Big ticket items and luxury goods are still selling mainly because high-end buyers – the driving force behind the current stage of the recovery – are always the last to exit when the Ferris wheel grinds to a halt.  Big spenders are still spending like there’s no tomorrow, which is why the stocks which comprise the NEI are still mostly in a rising trend.  Eventually this trend will reverse, however, when these big money spenders realize the economic picture isn’t as rosy as it was earlier this year.

In reality, the seeds to the next recession were sown when the Federal Reserve first hinted this spring that it would begin “tapering” the $85 billion/month asset purchases at some point later this year or early in 2014.  The taper talk led to a major spike in Treasury yields, which has all but torpedoed the bubble in income-oriented investments.  The yield spike has also begun to put cracks in the real estate recovery, as witnessed by the 13.4% plunge in new home sales for July.  Higher mortgage rates are beginning to bite into potential homeowners’ pocketbooks.

The seeds to the next recession – likely sometime in 2014 when the long-term Kress cycle bottoms – have already been sown by the very regulators who are supposed to keep the economy on an even keel.  The relentless tendency of the central bank to zig when they should be sagging is having a negative impact already on investor expectations, which is where declines in spending and investment patterns always begin.