Trade Growth - Decent November PMI Flash, But Growth Is Weakening

Every economic report should be reviewed with the understanding that economic growth is slowing. Good reports are either outliers or possible green shoots for a re-acceleration of GDP growth.

The October Markit PMI flash reading was solid even though other reports such as durable goods orders have signaled growth is rapidly slowing. The Markit PMI was more conservative and more realistic than the ISM reports in the first half of the year when economic growth was stronger.

Interestingly, the Markit PMI has been relatively resilient in the 2nd half, showing us it isn’t always conservative.

The November PMI was solid, but weakened slightly from the October reading. The composite flash reading was 54.4 which was below last month’s report of 54.9. This was a 2 month low.

The service activity index was 54.4 which fell from 54.8 and also hit a 2 month low. The manufacturing PMI was 55.4 which fell from 55.7 and was a 3 month low. Finally, the manufacturing output index was 54.5 which was a 3 month low and fell from 55.2.

Trade Growth - This report is consistent with GDP growth of 2.5%.

That used to be a problematic suggestion, but now it’s in line with estimates. The Atlanta Fed Nowcast expects 2.5% growth and the NY Nowcast expects 2.51% growth.

In the comment section of the report, the chief business economist at IHS Markit stated, “The November survey does raise some warning flags to suggest growth could slow in coming months. In particular, growth of hiring has waned as companies grew somewhat less optimistic about the outlook. Goods exports also appear to also be coming under increasing pressure, often linked to trade wars having dampened demand.”

As you can see, growth is solid. But if the weakening trend continues, there will be a problem. Goods exports will be hurt by the tariffs. The labor market is showing small signs of weakness as evidenced by GM’s layoffs and the spiking jobless claims.

Trade Growth - Global Trade Growth Below Trend

It seems like I have been talking about global growth weakness forever. But you must remember economies move slowly while markets move quickly.

As you can see from the chart below, the Q4 world trade outlook indicator was 98.6. That's down from the August reading of 100.3. It is the worst reading since October 2016.

The arrow below still isn’t in the below trend category. But technically the outlook for Q4 is below trend since it is below 100. This implies world trade merchandise volume growth will slow.

Besides the 2016 weakness, this is the worst slowdown since the 2008 financial crisis. Continued weakness next year, could quickly put this slowdown on par with the last one.

As you can see, none of the drivers of trade are improving. Merchandise trade volume, international air freight, and container port throughput are growing on trend.

Export orders, automobile production and sales, electronic components, and agricultural raw materials are growing below trend. All the indicators are falling except merchandise trade volume. That's from Q2 when the economy was much stronger.

Expectations for global trade growth are 3.9% in 2018 and 3.7% in 2019. That’s below 2017’s growth rate of 4.7%. Even though these estimates seem bearish, they really aren’t. They simply extrapolate current results.

Since the second half of 2018 has been weaker than the first half, the estimate for 2019 is near where growth is at now. If the economy continues to weaken and the proposed tariffs are implemented, trade growth in 2019 will be far below 3.7%.

Trade Growth - Dallas Fed Manufacturing Survey Shows Weakness

The November Dallas Fed survey was disappointing. Production index came in at 8.4 which was below October’s reading of 17.6. General activity index was 17.6. It missed estimates for 28.6 and last month’s reading of 29.4.

As you can see from the chart below, the Dallas manufacturing survey is following the weakness in cyclical stocks versus defensive stocks. It confirms the recent correction.

To be clear, the Dallas Fed survey is volatile and has a small sample size. It simply puts out the possibility that manufacturing growth slowed in November.

One big reason for the weakness was the decline in oil price.

This Fed district is highly reliant on the energy sector. And it may explain why the inflation calculations weakened. Prices paid index fell 20.7 points to 33.7 and the prices received index fell 10 points to 7.5.

Almost every category moved in the wrong direction on a monthly basis.

New orders fell 9.2 points to 9.7. The growth rate of orders index fell 6.2 points to 4.8. Capex index fell 15.3 points to 9.2.Company outlook fell 11.3 points to 13.7. Outlook uncertainty index increased 5.4 points to 12.3 which is a bad thing.

The 6 month expectations index wasn’t as weak. The production index increased 5 points to 52.9. The new orders index increased 1.7 points to 47.8. The employment index increased 9.2 points to 42. Capex increased 6.1 to 34.1. The bad news is the company outlook and general business activity fell 5.9 and 9.9 points to 31.4 and 25.7.

Trade Growth - Dallas Fed Comments

Now let’s review some of the comments to make sense of the sharp weakness in this report.

An electrical equipment, appliance, and component manufacturing firm stated, “The current U.S. trade policies are causing customers to rethink longer-term purchases due to trade war concerns and the impact of tariffs on virtually all imported raw materials. Tariffs on imported raw materials are making U.S. exports less competitive.”

The trade war’s effect on manufacturing will spread to consumer goods once the full suite of taxes goes into effect in 2019.

An equipment manufacturing firm stated, “Trade issues create a level of uncertainty for us as we face potential pricing and supply issues on aluminum and any items we buy that use source components from China. Changes at the congressional level may end up creating excessive friction for companies as well as fostering an anti-business bias among House Democrats looking to promote a progressive agenda. A potential drop in oil prices due to oversupply is troubling given what happened to the Texas economy the last time prices pulled back.”

This quote reviews all the negative catalysts which are tariffs, potential tax and regulatory increases from the Democrats, and the crash in oil prices.