A Sharp Drop Due to the Government Shutdown Would Likely Reverse Course

By | February 4, 2019

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Global shares crept lower from their highest levels in two months on Friday as shrinking factory activity in China dampened a rally that took them to the best January on record. The Caixin/Markit of Chinese manufacturing fell to the lowest level since February 2016, adding to a growing list of economic readings indicating slower global growth. The MSCI’s All-Country World Index, which tracks stock markets in 47 countries, came off its highest level since Dec. 4 after its best January gain on record, up 7.79% for the month. The weak Chinese data also took MSCI’s index of Asian shares outside of Japan down 0.2% on Friday, but that followed a 7.2% advance in January. Equity markets have been relieved by a change of heart by the U.S. Federal Reserve, which signaled that its three-year drive to tighten monetary policy may be at an end amid a suddenly cloudy outlook for the U.S. economy.

U.S. stocks ended mixed on Friday, after a tepid outlook from Amazon.com Inc. offset a stronger than expected jobs report. The S&P 500 was up less than 0.1% on Friday but ended the week up 1.6%. The Dow Jones Industrial Average advanced 0.3% on Friday and was up 1.3% for the week. Equity markets were buoyed id-week after the Federal Reserve signaled a more patient stance towards rate moves. Investors digested a better than round of economic reports including a better than expected rise in the manufacturing ISM and a strong employment report. So far this year, U.S. companies are beating analyst’s expectations for earnings, but to a smaller degree than normal and S&P companies are now barely expected to eke out an increase in profits in the first quarter. Fourth-quarter earnings are estimated to be up 15.5% from a year ago based on results from half the S&P companies and forecasts for the rest. That is not a bad return on a historical trend, but it is weaker than the first three quarters of last year. Financials are lagging so far this year and so is energy and technology, sectors that expected to continue weak for several months.

The Federal Reserve left its target range for the fed funds rate unchanged at 2.25% to 2.5% in late-January as expected. The statement included the buzzword “patient” in regarding the language about the policy outlook. The Fed is painting a picture of an economy that may not be as sturdy as it seems. The move by the fed “was not driven by a major change in the headline,” Fed Chairman Jerome Powell said in a press conference, but the fact that intensifying “cross currents suggest the risk of a less favorable outcome.” With U.S. growth expected to slow to perhaps 2% and risks accumulating, the economy is not in a great position to take a shock. Signaling a pause in rate increases is a way for the Fed to take out some insurance, in effect keeping monetary policy in place in hopes of skirting some of those risks. In December, Fed officials felt rates could climb higher in 2019, a sign of economic health. Instead, the bar for another rate hike has increased, which doesn’t speak well about the continued durability of the U.S. economy. The Fed is looking at signals that the economy will grow more slowly in 2019 than in 2018 and inflation has weakened. Bond yields has signaled that the prospects for strong growth are not there.

The Fed knows that some of the problems Fed is coping with are unavoidable, like Brexit and the slowdown in Europe. But on the list of worrisome factors are the involved domestic developments between the United States and its trading partners. Also, the federal government’s unstable fiscal situation. The federal government is back to work but for how long? The friction is starting to undermine business confidence. Certainty, some political resolution of trade and fiscal stability would help the Fed feel better about the economy’s prospects. However, until there is some more complete data on political moves, the Fed is sitting tight. With international developments weakening, the Fed is right with a waiting strategy.

The longest partial government came to an end last week but only with a tentative solution. Real GDP in the first quarter was probably reduced by 0.3% of a percent and that will likely spring back in the second quarter. Payrolls increased by 304,000 in January, but much of the big December increase was revised away. The big news of the week was the Fed meeting, where the committee introduced a key word for future policy, “patient.” Even with the government back to work, economic data remains delayed. As far as can be determined, economic growth is set to continue, but a more modest pace.

Next week, we will see the release of factory orders. Manufacturing activity appears to have softened over the past couple of months, but survey data has been running ahead of “hard” data. The November factory orders report was a causality of the government but a peek at the report souls provide some insight. Trade figures will also be released next week, again delayed a month. Companies rushed goods to get ahead of the tariff deadline and there is likely to be a first quarter offset. We will get some insight on the service sector, with the release of the ISM non-manufacturing index. A sharp drop due to the government shutdown would likely reverse course in coming months.

Latest Data

The U.S. Economy:

The pending home sales index dropped 2.2% in December to 99.0 from 101.2 in November. The decline was driven by three out of four Census regions, led by a 5.0% decline in the South. Potential home sales have been weakened in recent months by the sharp rise in mortgage rates and lack of affordability. The 30-year fixed mortgage averaged 4.9% in December, up 70 basis points from a year earlier. Supply constraints have put upward pressure on prices and are limiting home sales.  Higher incomes, more homes on the market and a pause in rate increases by the Fed should help boost sales modestly in coming months.

New home sales jumped 16.9% m/min November to an annual pace of 657,000, up from 562,000 in October. Sales remained down 7.7% from a year earlier. The median sales price for November was $302,400, down 12% from a year earlier. The housing market is feeling the effects of reduced tax deductibility and higher mortgage rates. The monthly movement seems large even for a series that is volatile month-to-month. Demand is shifting to lower price homes. Supply backlogs are elevated, with36% of homes sold have not begun construction. The outlook calls for a slow pace of construction, which may be good with an industry that has trouble finding qualified workers.

Construction spending gained some unexpected strength in November, rising 0.8%. The November increase was largely driven by a 1.3% surge in Residential construction spending.  The single-family residential component fell 1.8% and was down 1% for the year. Ex-home improvement residential construction spending fell 1.0%. Nonresidential construction spending fell 1.2% in November. Manufacturing nonresidential construction spending fell 0.3% in November and was unchanged for the year. Spending on commercial structures declined 0.6% but was up 0.6% y/y. Public construction spending fell 0.9%, the first decline since July. Construction spending surprised on the upside in November and the residential component would have been stronger except for the wild fires in California. Public construction has been a pleasant surprise, with year-over-year single digit increases. Still, single-family and nonresidential construction have not been winners, keeping the overall pace subdued.

The inventory build slowed down in November. Wholesale inventories increased 0.3% for the month, follow a 0.9% increase in October. The wholesale category diverged, with a 0.7% gain in durable goods stocks and a 0.5% decline for non-durable goods inventories. Wholesale sales fell by 0.6%, following another 0.6% reduction in October. The inventory-to-sales ratio edged up to 1.29 months from 1.28 in October.

The University of Michigan’s Consumer Sentiment Survey revealed that consumer confidence fell sharply in January to 91.2 from 98.3 in December. The present conditions index fell to 108.8 from 116.1. The expectations component fell to 79.9 from 87.0. The government shutdown and trade war uncertainty had a lot to do with falling confidence. Strong job creation and a turn upwards in equity markets are a plus for the consumer. If the government remains at work, confidence should rebound modestly in coming months. Confidence was starting to be undermined by political developments, suggesting the consumer is vulnerable to political gridlock.

The ISM manufacturing index increased to 56.6 in January, up from 54.3 in December. Production increased from 54.1 to 60.5, with growth in wood products, printing/related activities and furniture and fabricated metals. New orders increased from 51.3 to 58.2, with 11 out of 18 industries reporting growth. Inventories edged higher from 51.2 to 52.8. Supplier deliveries dropped from 59.0 to 56.2. New export orders declined from 52.8 to 51.8. Imports increased from 52.7 to 53.8. Backlogs moved slightly from 50 to 50.3. Prices paid fell from 54.9 to 49.6. Risks of recession have increased recently as the economy is slowing but production data suggests the economy is still well in the positive range. The recent ISM survey shows growth in new orders and production and restrained inflation. Comments from respondents were generally favorable. Trade and tariffs were referenced, but that is no surprise.

Vehicle sales started the year on a softer note, falling to an annual pace of 16.7 million in January, down from 17.6 million in December. Sales averaged 17.5 million in the last four months of 2018, juiced up by replacement demand from hurricanes and strong incentives. Considering the severe cold in January and the government shutdown, January’s sales were not too disappointing. Light truck sales were responsible for most of January’s weakness. Sales dropped by a full million to 11.25 million. Car sales held up, rising slightly from 5.3 million to 5.5 million. Incentives declined by 3% from December and by 1% from a year earlier. Given the strong labor market, rising wages and low gasoline prices, sales should remain at a decent level, near 17 million. As the fiscal stimulus fades and the economy slows, 2020 sales may track lower.

The labor market started off the year on a strong note, with the addition of 304,000 jobs. However, December was revised down from 312,000 to 222,000. Furloughed government workers were counted as employed, but the absence from work did push the unemployment rate up slightly to 4.0%. The large December revision was the result of the low survey response for the first print, at 61%. Likewise, January was low at 60.7%, compared with 68.2% in January 2018. A big downside revision is possible for January. January’s strength was led by a 232,000 gain in services. Goods producers was payrolls rise by 72,000, including 52,000 in construction. The annual benchmark revisions were small, with only 7,000 jobs added in the preliminary estimate. Average hourly earnings rose by 3 cents, translating into wage growth of 3.2% year-over-year. With inflation moderating, this is a real wage gain. The labor market will remain decent this year, but employment gains are likely to moderate to 170,000 by year’s end, compared to the 223,000 average for 2018.


Factory activity was at its weakest level in years in January across much of the world adding to worries that trade tariffs, political uncertainty and cooling demand poses a threat too global growth. Trade-focused Asia appears to be suffering the most visible loss of momentum. Activity is shrinking in China. Europe is stuck in low gear and many e/merging markets are sputtering. The Caixin/Markit PMI for China fell to 48.3 in January from 49.7 in December, the lowest reading since February 2016. Korea, Malaysia, and Taiwan’s PMI were below the 50 mark in December. The official PMI rose to 49.5 from 49.4. Both indexes signal contraction in factory activity. Germany’s manufacturing sector contracted for the first time in four years, with the manufacturing PMI dropping to 49.9 in January. France’s PMI did improve to 51.2, helped by employment growth. The euro-zone’s manufacturing PMI was 50.5 in January. British factories are stockpiling goods at the fastest rate since record began in the early 199s as they brace for a possible chaotic Brexit. Yet growth is weaker than expected and optimism is waning. The International Monetary Fund cut its world growth forecast for this year and said failure to resolve protectionism could further destabilize the global economy.

Important Data Releases This Week

November factory orders will be released on Monday, February 4 at 10:00 AM EST. Advance data for the durables side showed a 0.8% increase in orders reflecting a positive input from both civilian and defense aircraft. Ex-transportation orders fell 0.3% with core capital goods down 0.6%. We look for orders to increase 0.3% in November, with the addition of nondurable goods.

The January ISM non-manufacturing index will be released on Tuesday, February 5 at 10:00 AM EST. Business activity slowed and delivery time improved in December but new orders were strong. The index is projected to come in at 57.1 for January, down from December’s revised 58.0 reading.

November international trade will be released on Wednesday, February 6 at 8:30 AM EDT. Forecasters expect the trade deficit to come in at $54.0 billion, compared with the deficit of $55.5 billion in October.

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About Steve Graham

Steve is one of the premier analysts in the transportation equipment industry. On a monthly basis Steve tracks and analyzes in detail the trailer and heavy-duty truck industry. Aside from following these two sectors he is also instrumental in helping our customers analyze the economy and its impact on transportation and transportation equipment.