“Bad economic data emerges, stockmarkets fall. Investors then predict an interest-rate cut, and stocks rise,” says John Foley on Breakingviews. That familiar pattern played out again last week in the US, when the S&P 500 closed higher even though the latest Institute for Supply Management (ISM) surveys suggested a contraction in the manufacturing sector and a sharp slowdown in services. Yet while it’s not entirely a shock that US growth is slowing down after more than a decade of steady expansion, the market’s reaction “certainly looks too sanguine”.
Most economists still don’t expect a recession: consensus forecasts are for around 2% annualised growth in the next two quarters. But what if the slowdown worsens? The push to impeach President Donald Trump means that odds of Democrats and Republicans co-operating on measures to boost the economy – such as tax cuts, extended unemployment payments or infrastructure programmes – are slim. And in that situation, the idea that the US Federal Reserve can hold off a recession by rate cuts alone is optimistic. “Monetary policy has its limits.”
The economy is still in good shape
There’s no need to worry too much, says Randall Forsyth in Barron’s. The ISM surveys still point to an economy that is growing overall. And harder economic numbers look more encouraging: unemployment has fallen to 3.5%, the lowest it’s been since 1969, when The Beatles’ Abbey Road – coincidentally just re-released – was topping the charts. Meanwhile, the non-farm payrolls report (see below), which measures new jobs added, only missed expectations because data for the past two months has been revised upwards.
In short, the economy is still in decent shape. The reality is that growth is slowing at least partly because of the effects of the previous round of rate rises. And with monetary policy now “tilted away from restraint” and inflation low, the Fed should have enough “leeway to lower rates to sustain the expansion” – and by extension the equity bull market.
Jobs are the last thing to go
The Fed itself might not be quite so confident, says Justin Lahart in The Wall Street Journal. Yes, the employment data will come as a relief, but rate-setters are aware that “jobs are one of the last things to go when the economy turns sour, with companies cutting back on other items, such as advertising and capital spending, first”. What’s more, firms have been cautious in adding employees since the crisis, so they have “little fat to cut in their workforces” and may not begin firing unless they see an outright drop in demand. “At that point, the economy might not just be at risk of falling into a recession, but already in one.” So the Fed will cut next month and continue cutting “as long as those alarm bells keep ringing”.
That may well keep the boom going. Still, MoneyWeek suggests having 5%-10% of your portfolio in hedges such as gold – which tends to do well in bear markets – in case the Fed’s efforts ultimately fall flat.
Non-farm payrolls: the overhyped statistic that moves markets
The Bureau of Labor Statistics’ monthly non-farm payrolls report sounds immensely dull, but it is one of the most closely watched pieces of economic data in the US. As the name implies, this tracks employment outside the agricultural sector – the reason for leaving out farm jobs is that they tend to be both highly seasonal and difficult to count. The figures also exclude many workers in government, private households, non-profit organisations and the self-employed, but in total they cover jobs contributing to around 80% of GDP.
The latest data is normally released on the first Friday of the following month (ie, the report for September was out on Friday 4 October), so it’s available extremely quickly compared to many other statistics. This explains why markets latch onto it. The only problem is that it’s not very useful: Bloomberg columnist Barry Ritholtz described it as “the most overhyped, over-analysed, overemphasised, least-understood economic release known to mankind”.
There are two obvious weaknesses. First, the US workforce is almost 165 million. The net number of jobs added in any report is tiny by comparison: the October figure was 136,000 – ie, less than a tenth of 1%. In short, each month’s change is a rounding error.
Second, this is a very noisy set of data subject to major revisions after one month, two months and then annually for many years. In the latest release, the number for August was revised from 130,000 to 168,000 – almost 30% higher. Over time, the cumulative revisions are enormous.
The long-term trend is useful for identifying the start and end of recessions and other major shifts, but only with enough hindsight. Making investment decisions based on the monthly release is nonsense. But that doesn’t stop markets doing so.