With apologies to the Ghostbusters, their classic line really applies today as we look at the economic news coverage. Who you gonna
call trust, the bulls or the bears?
The headline which received the most traction (two of them actually) were “Durable Goods Orders Decline 2% in August” right next to “Caterpillar Announces Layoffs”. The second was meant as proof of the implication in the first headline – the economy is starting to wobble and fall, and proof is right there at the Caterpillar factory door. The only problem is that the implication was and is wrong.
Yes, it’s true that after two consecutive months of very strong gains, new orders for durable goods took a breather in August dropping 2%. However, even including August’s decline, orders are accelerating, up at a 16.9% annual rate over the past three months. A big chunk of the decline in August came from the very volatile transportation sector, specifically a 1.6% drop in autos, and a 5.1% drop in civilian aircraft orders, which helped bring the overall transportation sector down 5.8% for the month. Orders excluding transportation were unchanged in August and are also accelerating, up 5.6% annualized over the past three months.
The bottom line here is that the recent trend in orders is improving on a broad basis, not just in the volatile transportation sector. Some pessimists may point out that orders are down 2.3% from a year ago, but this doesn’t tell the whole story, as the decline is due almost entirely to the precipitous drop in energy prices since mid-2014, which has cut into orders related to drilling for energy. We believe oil prices will average at higher levels in the next few years, so these factors are temporary. We expect stronger gains in durable goods order in the year ahead.
What Caterpillar has to do with all that is anyone’s guess. We’re not students of Caterpillar per se, but would remind everyone that even in good economies, there are liable to be individual companies which have fallen on hard times, have missed their sweet spot in the market, or have just failed to adapt to change. For every one of those, there is a competitor who is gobbling up market share. News coverage is fickle, and Caterpillar’s hiring plans are anecdotal at best.
The other strong sector data, which supports the economy-is-still-growing theme in which we put our confidence, is the fact that new single-family home sales increased 5.7% in August. This was a surprise to many of the analysts who expected much lower numbers. The August sales number is actually the highest level since February of 2008.
But let’s put all the sector data aside and look at the entire economy. Fortunately for the timing of this commentary, we can do just that. According to the government gnomes who track and measure all this stuff, real GDP growth for the 2nd quarter was revised to a 3.9% annual rate. That’s a pretty significant fact (not just a factoid) with which those who want to preach doom and gloom have to deal. Keep in mind that only two months ago, the original report for the 2nd quarter indicated that the economy grew at 2.7%.
The other piece of good news today was that economy-wide corporate profits were revised up and climbed 3.5% in the 2nd quarter. On top of that is the fact that actual cashflows for these same corporations economy-wide climbed 6.3% in the 2nd quarter to a new record high.
We’ve probably bored you enough with all the facts and figures, but it’s important to run through them in the face of the unrelenting negative naysayings which are passed off as serious reporting. These figures unequivocally support the case for trusting optimism for the economy and the equity markets.
But, some may ask, why has there been such a market correction (off 15% at its low) if the economy is good? The answer is that confidence is fragile. It has been building over the years since 2009/09, but it is still fragile and susceptible to being spooked. And that is exactly what the Fed did with their decision NOT to raise interest rates.
We realize that sounds strange; the market dropped because rates didn’t go up??? That’s exactly right. The Fed has signaled for so long what its targets are in unemployment, factory utilization, inflation, etc., and everyone of those targets has been achieved. Investors were rightly convinced that the Fed would raise interest rates.
When the Fed failed to raise them, the markets immediately wondered, “what does Janet Yellen know that she’s not telling us?” The mistaken conclusion was that there is some secret data the Fed Governors have which tells them the economy is in trouble.
That’s all it took – actually starting with the trial balloons the Fed sent up hinting that there might not be a raise in rates – to spook the markets downward. Notice that when Janet Yellen stated yesterday that the Fed would raise rates this year the market bounced back up. It will take awhile to restore the confidence that was building, but ultimately, the markets will reflect the true health of the economy.