Why economists are shrugging off weak data

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The economic data continue to be weak, with another manufacturing read and some jobs data confirming softness Wednesday. Yet economists aren't seeing recession ahead.

The Institute for Supply Management-New York’s current business conditions index dropped to a 40-month low of 42.8 in September, after a 50.3 reading in August. The read was the lowest since a 37.2 level in May 2016.

The six-month outlook plunged to 45.2 in September from 71.4 in August, and is the lowest level since a 33.0 reading in February 2009.

This follows Tuesday’s national ISM report, which slid to 47.8 in the month, its lowest level since June 2009. It has fallen each of the past six months.

In the ISM reports, numbers below 50 reflect contraction in the sector.

“The decline in the ISM this month was particularly striking because it contrasted with what appeared to be more positive indications from other manufacturing surveys,” according to a Morgan Stanley Research report.Regional Fed manufacturing surveys, for example, showed modest upside this month, on balance, as did the Markit manufacturing PMI.”

“The sharp divergence between the ISM and other indicators does suggest that one-off factors may have been at play, at least partially,” according to Morgan Stanley. They suggest “the ISM is reflecting negative sentiment from global economic conditions more substantially than” the other surveys.

“The weak ISM may be telling us something we already know — weak global growth and trade tensions are likely to continue weighing on industrial sector activity. Also, insofar as ISM new orders goes into our recession risk model, recession risks will remain elevated.” But while ISM needs to be monitored, “it is not on its own the final judge of the near-term economic outlook,” Morgan Stanley says.

The “U.S. manufacturing sector is in the midst of a recession,” said Joel Alcedo, Macro Quant Strategist & Data Scientist, BNP Paribas Securities. “Uncertainty on the part of manufacturers tends to drag business fixed investment, which we think will contract in Q4 2019 and Q1 2020 before stabilizing.”

Sentiment has been weak since the last half of 2018 as a result of U.S.-China trade tensions, “a retrenchment of capex spending intentions and a strong dollar,” and business fixed investment likely to contract for the next half year. “This supports our view that the Fed will cut [the Fed Funds Rate] an additional 25 [basis points] in December,” Alcedo wrote.

“There’s no way to describe the ISM manufacturing reading other than ugly,” said Mark Hamrick, senior economic analyst at Bankrate.com. “And it wasn’t just the headline number which showed contraction in the nation’s factory sector, it was the various sub-components as well, including a step drop for new export orders, as a gauge of demand coming from around the globe.

“While much of the focus on the divergence of the U.S. and global economies have been in the context of taking an upbeat view, it is worth repeating that this is the U.S. manufacturing sector which has contracted for two straight months,” he said. “This combined with weakness in the nation’s agricultural sector, and the transportation network needed to move factory and farm goods, and you are talking about no small part of the U.S. economy.”

A Bankrate survey recently suggests a 40% chance of recession by the November 2020 election. And with the latest data and the continuing trade issues, “one can surmise that these risks are likely to rise,” he said.

Will weak manufacturing pull the U.S. into recession?

“Concerns are growing that manufacturing weakness could be the domino that takes the U.S. economy into a recession, but that is unlikely to be the case as long as the U.S. consumer remains relatively strong,” said Edward Moya, senior market analyst, New York at OANDA. “The current environment is more like a mini-recession. A few decades, ago manufacturing weakness could tip the U.S. into a recession, but probably not so much now.”

And, just because the numbers are dropping doesn’t mean that will continue. “The numbers can always turn back up as they did in 2011 and 2016 when recession calls were out there,” said Kirk Kinder, owner and financial planner at Picket Fence Financial. “This seems to be a deeper issue right now. The Central Banks are already full throttle, and we see the weakness {in these reports] along with European economies receding and a very important South Korean exports. In addition, it looks like tax revenues are slowing — another dubious sign.”

Also spooking the markets today, Democratic presidential candidate Bernie Sanders canceled appearances after he suffered chest pain, resulting in his hospitalization and a stent procedure. The concern is that if Sanders drops out of the race, or if voters question his health and switch, Elizabeth Warren would be the beneficiary.

“Wall Street has been becoming increasing nervous that Senator Warren is anti-business and would look to break up a lot of the big tech stocks,” Moya said, “and Wall Street is scared of an Elizabeth Warren presidency.”

Separately, ADP reported private-sector employment rose by 135,000 in September, on a seasonally adjusted basis. Its August number was lowered to a 157,000 gain from the originally reported 195,000 rise.

“Businesses have turned more cautious in their hiring,” said Mark Zandi, chief economist of Moody’s Analytics. “Small businesses have become especially hesitant. If businesses pull back any further, unemployment will begin to rise.”

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