Solid Core Capital Goods Orders Growth

There are a few details that cloud the November durable goods orders report making headline growth not very useful. Some have argued that we should just look at the headline numbers because there are always one time factors that cloud them. Firstly, if there is always a reason to ignore the headline numbers, then you should ignore them. That would mean they always are compromised. Secondly, saying they are always compromised is a bit dramatic.

There were a couple of one time factors that were extremely impactful in this report. Reviewing one time factors takes extra effort, but it always must be done. If you don’t bother with that, then you will completely misread the data. You might think the economy is on fire because a few big orders for aircrafts came in. That would be a mistake because those orders likely won’t be repeated.

Headline new orders growth was -2% monthly which drastically missed estimates for 1.5% growth. Plus, the October reading was revised down from 0.6% to 0.2%. That sounds terrible, but the details explain the weakness. The most important one time impact was the 72.7% decline in defense aircraft parts. Excluding defense goods, orders were up 0.8%. 

In other words, this was normal-sized miss opposed to a complete disaster. Aircraft orders are volatile. Plus, I care more about private sector orders than public sector orders when measuring the economic cycle. Defense orders can increase at any time. The biggest spike in aircraft orders ever was in the 2001 recession due to the 9-11 terrorist attack. The October growth rate was negatively impacted by the extension of the GM strike. Once we get to December’s report, there will be no impact from the GM strike and there won’t be easier comps because of the strike.

(Click on image to enlarge)

Excluding transportation, monthly growth was 0% which missed estimates for 0.2% growth. The October growth rate was revised from 0.6% to 0.3%. You can see in the chart above, the 1 year moving average of orders growth has been suppressed by the transportation industry. It added to the cyclical peaks in 2014 and 2018 and suppressed the downturns in 2016 and 2019. Core durable goods orders were up 0.1% monthly which beat estimates by a tenth. 

Growth was revised lower by a tenth in October to 1.1%. Yearly headline orders growth fell from -1.2% to -3.7%. which was still above the cycle low of -5.8% in September. Yearly non-defense capital goods orders growth excluding aircrafts improved from -0.8% to 0.5%. That’s the quickest growth since June. 2-year growth stack had a vast improvement as the comp went from 4.1% to 6.1%. And 2-year growth stack went from 3.3% to 6.6%.

Part of the weakness in headline orders growth came from the drop in private aircraft orders which fell because of the slight weakness caused by the grounding of Boeing’s 737 MAX. It has been grounded since March 13th. Since then, Boeing’s stock has fallen 24%, making it one of the worst-performing big-cap names. 

United Airlines has delayed the return of the Boeing 737 Max until March 4th. Southwest and American Airlines delayed flights until March 6th and 5th. Once the issues with the plane are sorted out, airline orders will drive overall growth and help Boeing. Analysts believe that will happen in early 2020. They see its stock rising double digits.

CFO Confidence Improved In Q4

Perma bears have loved discussing the negative CEO and CFO sentiment this year. This was yet another example of an indicator that predicted the past 2 recessions but was wrong this time. There have been many indicators in this 10.5-year expansion that have done that. Many knew these indicators were wrong. Yearly change in their confidence was consistent with the worst of the prior recessions. 

While it’s debatable whether the weakness in 2H 2019 is the start of a recession, we know for sure it’s not the worst of one. Many indicators are late in predicting the start of recessions, but they are usually all in sync by the end of them. For example, in 2H 2008, almost all indicators were giving off terrible results.

In this article, let's discuss the improvement in the Duke CFO confidence index. Another indicator often cited is the Conference Board’s CEO confidence index. While neither of these correctly signaled the start of a recession or a decline in stocks, they were correct in telling us about the weakness in business investment growth as it was negative in Q2 and Q3. I think it will be negative in Q4 as well. That makes these indicators worth following.

As you can see from the chart below, CFO’s optimism on the U.S. economy increased from 62.6% to 66.6%. Optimism on their own company increased from 67.1% to 75% which is a cycle high. As you can see, this report showed weakness on a rate of change basis earlier in the year. Absolute weakness wasn’t as bad as the CEO confidence indicator.

(Click on image to enlarge)

The weighted average estimate for the next 12 months earnings of growth increased from 3.3% in Q3 to 4.5% in Q4. 1-year capital spending growth estimates rose from 0.6% to 4.7%. Business investment might rebound in 2020. 1 year projected revenue growth rose from 4.8% to 5.5%. Since earnings growth estimates rose quicker than revenue growth estimates, it means margins are expected to fall less. Wages and salaries growth expectations rose from 3.9% to 4.4%.

Even with these improvements, perma bears still have something to hang their hat on. CFOs are predicting a recession. 52% think America will be in a recession by Q4 2020 and 76% see a recession by mid-2021. Their biggest concern is attracting and retaining qualified employees and their 2nd biggest worry is economic uncertainty.

Therefore, it’s no surprise management teams are preparing for a recession. Ironically, if firms are prepared for a recession, it will mitigate the impacts of the economic downturn. However, negative business investment hurts the economy now. 59% of firms are strengthening their balance sheets, 58% are cutting costs, 29% are increasing liquidity, and 31% are lowering or delaying investment. That last stat is the issue. Hopefully, fewer firms do so in 2020.