Our First Official Recession Signal
Everyone knows the economy is headed for a recession. Only questions are how long and deep it will be. This is the most unusual situation many have ever seen. Even in the terrible financial crisis, people didn’t know a recession has started as late as Q2 2008. We had a period where the most bullish investors denied the weakness in this recession, but it was squished into a couple weeks. In late February, some denied the possibility of a recession, but by early March everyone was on board with the call.
Before a few days ago, we hadn’t gotten any official data showing the economy is weakening. Before Thursday, we hadn’t gotten any confirmation of a recession from reports considered critical. You shouldn’t use regional Fed manufacturing reports to confirm recessions because there can be manufacturing recessions within expansions. Thursday’s jobless claims report was the first official confirmation that the economy is headed towards a recession.
As you can see from the chart above, initial claims rose from 211,000 to 281,000 which was above estimates for 220,000 and the high end of the estimate range which was 240,000. This isn’t recessionary yet, but recognize that this report was from the week of March 14th. Weakness in the labor market was mostly in the end of the week.
Claims will likely jump to above 350,000 in the next report as the shutdowns have gained steam in the past few days. Plus, small businesses are about to face serious trouble. Average small business has 15 days of cash. That’s not enough to deal with this economic shutdown which might last 8 weeks. Even government loans won’t help most survive.
Very Weak Philly Fed Reading
It’s no surprise the Philly Fed report was terrible because the Empire Fed reading was very weak. We are in a manufacturing recession. Manufacturing sector’s recession will likely start in March. China has been in rough shape since the end of January and Italy has been in rough shape since the end of February.
As you can see from the chart below, the Philly Fed index fell from 36.7 to -12.7 which missed estimates for 14. It actually beat the lowest estimate which was -20. It was the lowest reading since July 2012. Regional Fed reports imply the ISM PMI will fall to 44 which is down 6 handles from February.
Finally, we are seeing estimates come down. Most reports will miss estimates in March, but they might start beating estimates as early as May. It depends on how long the economic shutdown lasts. It’s possible the shutdown ends in the spring, but restarts in the fall. Everything is on the table. This was the biggest monthly decline in the Philly Fed index ever. We have data that goes back until 1968. That’s a 5 standard deviation decline.
New orders index fell from 33.6 to 15.5. Manufacturing sector had been doing well in February before this sharp weakness. Manufacturing sector was about to have its greatest year since 2018. But that possibility has been eliminated by COVID-19. Shipments index fell from 25.2 to 0.2. 6 month expectations index wasn’t terrible. It fell from 45.4 to 35.2. It’s possible that firms see this as short term weakness. While it is temporary weakness, it might last longer than 6 months.
Best case scenario is the economy starts to re-open in 2 months and gets fully back on line by the summer and a cure is found. New orders index fell from 54 to 36.7 and the shipments index fell from 51.9 to 41.8. Empire Fed capex index was solid, but this report showed a big decline in capex as it went from 29.8 to 12. Capex in the overall economy is set to plummet in the next few weeks. Firms can’t pay their workers let alone invest in their business.
Negative Projections Keep Coming
Negative economic forecasts keep coming out. At this point, no economic forecast for Q1 or Q2 can phase this market. Even extremely negative forecasts are priced in. The market is trading on the 2nd half of 2020 and the fiscal stimulus. And the market trades off uncertain events, not what’s priced in.
It’s uncertain how bad COVID-19 will get and when it will get better. Also, it’s uncertain if it will come back later this year and if a cure will be found. It’s also uncertain how big the next stimulus will be or if what has passed is all that will come out. And it’s not uncertain that the economy will be bad in Q2. That’s why many are unphased by Merrill Lynch’s latest forecast.
Merrill is calling for a 12% drop in Q2 GDP growth. The firm expects 3.5 million jobs to be lost. In Q2 there will be 1 million jobs lost per month and there will be 500,000 jobs lost in March. This will nearly double the unemployment rate to 6.3%. Record streak of job creation will end in March. We know the March report will be weak because claims spiked in the latest reading. Claims will increase further in the next report which is the survey period for the monthly BLS reading.
Earnings Estimates Still Need To Fall
As you can see from the table below, earnings estimates cratered on March 19th. Estimate for Q1 fell 0.3% to -2.86%. With 6 firms reporting earnings, EPS growth is -2.97%. Normally, if estimates were this low, we would expect positive EPS growth because firms beat estimates by about 4% to 5% on average.
However, estimates will likely fall much further between now and when most reports come out. If they don’t fall, estimates will be missed. Q2 EPS estimates crashed sharply. This is the biggest 1 day decline I’ve ever seen.
As you can see, it fell from -0.35% to -1.72%. Estimates will fall dramatically during Q1 earnings season as firms suspend guidance. Q2 EPS estimates could fall to the negative double digits by the time Q1 earnings season is done.
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