Very Weak Chicago Fed Business Barometer

Recession fears are back on the table with the latest weak ISM manufacturing PMI. The market under-reacted to weak economic reports earlier in the year; now it is overreacting to them. Q3 was always going to be a weak quarter as I highlighted at the start of the year when the ECRI leading index was very weak. 

However, based on the strong housing data and low jobless claims, I don’t see a recession coming soon. Q3 might be the trough of this cyclical slowdown. If stocks are supposed to lead the economy, they might rally over the next 6 months. The strength of the economy in 2020 partially depends on the trade negotiations next week. That means volatility could come soon as I forecasted.

It’s interesting how the market completely ignored the very weak September Chicago business barometer that came out on Monday but is following the ISM PMI so closely. Let's now review the Chicago PMI. It was a very bad report as the PMI fell from 50.4 to 47.1 which missed estimates for 50.4 and the low end of the estimate range which was 47.2. Q3 average was the worst reading since Q3 2009 as it fell 4.9 points sequentially.

As you can see from the chart below, the current PMI is below many of the readings in 2008. At least the recent low was above the low in December 2015. Either this is nearly as bad as it will get, or a recession is coming in late 2019 and early 2020. This isn’t a new phenomenon, but equity investors are acting like they slept through the whole year and just realized there is a trade war and a cyclical slowdown.

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Chicago Fed Signals Weakness In The Service Sector

Let’s look at the details of this PMI reading. Supplier deliveries and employment were the only indexes that increased monthly as they were 54.8 and 45.6. Remember, this survey includes both manufacturing and services which means employment is much weaker than jobless claims suggest.

This index being below 50 is another reason why I’m nervous about the BLS report. Increasing odds of rate cuts won't save the market if there is a bad report. S&P 500 could fall at least 1% if the BLS report shows less than 100,000 jobs created. Production index had the biggest decline as it fell 7.6 points to 40.4 which is the lowest reading sine March 2009 which is when stocks bottomed. This is even worse than the ISM reading.

Remember, the bulls are arguing that the economic weakness is centered in manufacturing, but the service sector is fine. This report disagrees. Both the ISM and Markit services PMIs will be released on Thursday. Stocks will fall sharply if the ISM PMI misses estimates. The consensus estimate for the Markit services PMI is for a 0.2 rise to 50.9. And the consensus for the ISM PMI is for it to fall from 56.4 to 55.5. At least this consensus is expecting a decline, so the bar is lower. No one expected the manufacturing PMI to fall from August.

Unlike the ISM and Markit reports, new orders fell 7.6 points to 48.5. Backlogs fell from 51.3 to 46.8 which is like the Markit and ISM reports showed (ISM fell from 46.3 to 45.1). Just like the ISM report, inventories fell 6.2% to 41.7 which was a 40 month low. 

The quarterly average for labor demand fell to 44.1 which was the lowest reading since Q4 2009. Just like the ISM report, the prices index rose 4.1 points to 57.7 in Q3 as tariffs caused prices to rise and hurt business activity. As you can see from the chart below, the 3.7 point increase in the ISM prices index to 49.7 was rare for a monthly reading where the overall PMI fell sharply. This could mean the prices index is about to fall.

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September ADP Report Misses Estimates: Bad Sign For BLS

Supporting nervousness about the BLS report, the September ADP report showed private-sector job creation was 135,000 which missed estimates for 152,000. August reading also wasn’t that strong as it was revised from 195,000 to 157,000. ADP report has been running above the BLS report, so it could still indicate less than 100,000 jobs are created. You can tell ADP is running hotter because estimates were for 152,000 and estimates for private-sector job gains in the BLS report are 135,000.

As you can see from the chart below, the ADP report’s initial readings in the last 10 September reports have been above the BLS report 8 times. ADP report was above the BLS report by an average of 142,000 in the past 2 years. If this report shows a decline of 7,000 jobs, it would send the S&P 500 crashing at least 2%.

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Details Of ADP

Let’s look at the details of this report. The good news is small firms didn’t drive job creation lower as these firms added 30,000 jobs. Very small firms with 1-19 employees only added 4,000 jobs which isn’t ideal, but not as terrible as earlier in the summer. 

Mid-sized firms added 39,000 jobs and large firms added 67,000 jobs. It’s no surprise that education and healthcare drove job creation as the industries added 42,000 jobs. Trade, transportation, and utilities added 28,000 jobs which helped the total for the service sector get to 127,000.

The goods-producing sector only added 8,000 jobs as manufacturing added 2,000. Considering the weakness in the PMI reports, 2,000 jobs added in manufacturing is a minor victory. This reading is almost exactly in line with August’s BLS report and expectations for September which are both 3,000. I expect negative job creation in this sector. Overall growth will be helped by the government because of the census. Consensus has the government adding 10,000 jobs. That might be better than most sectors.