Global Growth Falters - Classic Late Cycle Economy

The latest catalyst for stock market weakness is global growth. Global growth weakness matters a lot more when the American economy is also weakening.

Fiscal stimulus delayed this weakness from impacting America for the first 3 quarters. But unfortunately, global growth has fallen further. And, the fiscal stimulus is running out of juice.

The labor market can’t be the savior of the economy because once businesses start faltering, job creation will stall. Q3 was a classic example of a late cycle economy. The labor market is a lagging indicator.

It drove consumer spending, but won’t do so once it starts following growth lower.

With that idea in mind, the preliminary November consumer sentiment report showed the holiday shopping season will likely be strong.

It fell from 98.6 to 98.3 which beat estimates for 98. That’s a great number as 2018 is about to be the best year for consumer sentiment since 2000. As you know, the 2001 recession followed that great year.

This shows how the consumer is the strongest right before recessions. The disconcerting part of this report is the current conditions index. It was up slightly to 113.2 and the expectations index fell 1.6 to 88.7.

The difference between the current conditions and expectations index is widening. That has been a predictor of recessions in the past 2 cycles.

Expectations for 1-year inflation fell 0.1% to 2.8%. Expectation for 5-year inflation was up 0.2% to 2.6%. Inflation expectations are low which in tune with the CPI and PCE reports from September.

As I have mentioned, lower oil prices will increase consumer spending this holiday season. If the Fed decides to stop hiking rates because of low inflation, this cycle will last a few more quarters.

However, the Fed has signaled it will stay the course with rate hikes.

Global Growth Falters - Italian Economy Weakening

The weakening global economy is partially responsible for the coming slowdown in America. First, let’s look at the weakness in Italy.

Service sector activity fell first time since May 2016 according to the October Markit services report.

As you can see from the chart below, business activity was the worst in 44 months as the PMI was 49.2. It signals there will be negative GDP growth unless this report is a blip.

Based on the global weakness, I highly doubt this is a blip.

Global Growth Falters - Italy will likely fall into a recession in the next few quarters.

That’s terrible for its weak banking system, high government debt, and an unstable political system. Business margins were hurt because input costs increased, albeit less than in September, while business activity fell. The good news is rising fuel costs were blamed for inflation; that will reverse as oil has been falling. The problem is oil is falling because of weak global growth.

The labor market in Italy also expanded. That will reverse once the Italian economy falls into a recession. The Markit commentary tried to put lipstick on a pig by saying, “After a period of solid growth in activity, the latest survey data marked a substantial reversal of fortunes for the service sector, raising worries that economic growth may ease in Q4.” Growth has already been easing. The worry is an outright recession.

Global Growth Falters - Weak German Exports

As you can see from the chart below, German exports are faltering as growth has fallen below 5%. The German economy thrives on exports especially since it entered the EU which allowed it to have a weaker currency. The latest weakening of the euro versus the dollar hasn’t been enough to help the German economy. The dollar is strengthening because of a hawkish Fed which is bad for the American economy. Furthermore, the weakness in the European economy hurts the euro. The weakness in Chinese demand was masked by the strong pre-buying before the American tariffs go into effect. There wasn’t pre-buying of German goods since there isn’t a trade war between Germany and China. As you can see from the red line below, expectations have been weakening. This implies German export growth will fall further and possibly go negative.

The German October Markit PMI wasn’t as weak as the Italian PMI, but it was problematic in rate of change terms. The services PMI fell from 55.9 to 54.7 which is a 3 month low. This caused the composite PMI to fall from 55 to 53.4 which is a 5 month low. Once again, we see the labor market was strong in another economy. The pace of job creation was among the strongest in 11 years. To be clear, this was a decent report, but with German GDP estimates falling and export growth weakening, rate of change weakness in the Markit PMI reinforces the negative global growth trend.

Global Growth Falters - Yield Curve Done Flattening?

Since the Fed is expected to hike rates in December and has guidance for more hikes in 2019, it doesn’t seem like the yield curve is done flattening. However, as you can see from the chart below, if the trend of the curve flattening less and less each cycle continues, then the difference between the 30-year yield and the 10-year yield is at its trough. The end of the curve flattening means a recession is coming quickly. The flattening between the 30 year and 10-year yield was 126 basis points this cycle which is 5 basis points more than the average of the past 3 cycles. There no rule this trend needs to continue. There may be more flattening. I’m still focused on the difference between the 10-year yield and the 2-year yield which hasn’t inverted yet.

(Click on image to enlarge)

Global Growth Falters - Conclusion

The American consumer is strong. The labor markets in America, Italy, and Germany are strong. However, there are signs global growth is slowing which means there could be a global recession in 2019 and an American recession in 2020. The Italian PMI fell below 50, German export growth is slowing, and the difference between the 30-year treasury yield and the 10-year yield has flattened more than the last cycle.