Monday, March 21, 2016

Expect A Recession By Year End – So Says The Commercial Truck Market

Right into the Danger Zone
Highway to the Danger Zone
Right into the Danger Zone
                             Kenny Loggins

Economic recessions are incredibly hard to predict.  The next one, even more so, because the Great Recession was so impactful that some economic indicators and industry cycles have yet to return to a “normal” state.

This is important because forecasters use current conditions, combined with past conditions and trends, to predict the future.  If you do it any other way, you are either guessing or you are psychic.  Now I have been accused of being psychic, which is actually a good thing in this case.  It means your forecasts are accurate and people can’t figure out how you did it.

Regarding the upcoming recession (everyone can agree that recoveries don’t last forever), there is naturally a wide divergence of opinion.  That is because a wise man once wrote “Economic recessions are incredibly hard to predict”.  The forecasts regarding the next 12 months are:

There Definitely Will Be A Recession

Rogers Holdings Chairman Jim Rogers said in a recent interview there is a 100% probability there will be a recession before March 2017.  Rogers is a well-respected investment executive, so when he says 100% it gets your attention.  So it’s looking bleak in Mr. Rogers neighborhood.

There are many other economists predicting a recession.  They make solid, logical, arguments using the standard charts and graphs.  They explain that the yield curve is not yet inverted (a recession predictor) but they can explain why it really is, or should be.

There Definitely Won’t Be A Recession

You can read commentaries and analyses from other respected economists proclaiming the economy is fine, is expected to get better, and there is no recession in sight.  They also use the standard charts and graphs to buttress their forecasts.  And after all, the yield curve is not inverted.

ECRI (Economic Cycle Research Institute), whose specialty is forecasting recessions, is not predicting one yet, even though its leading index is steadily declining.  The institute is probably being cautious after forecasting a recession in 2012, which never happened.  FTR is forecasting continued weak economic growth, but no recession.

Using The Commercial Vehicle Equipment Market To Calculate The Next Recession

Reading all the commentaries and analyses is confusing, so what can the commercial equipment market tell us about our economic future?  Well, our industry is a leading indicator for the economy.  I determined this years ago when my bosses assigned me the difficult task of finding the leading indicator for the commercial vehicle market.  After month of study I determined there was nothing in front of us, therefore we’re the lead car on this train.

My theory was confirmed soon after that when I attended a presentation by a General Motors economist and she said they track commercial vehicle sales closely because it is a leading indicator for the general economy.  This is not a new phenomenon.  The Dow Theory, developed in the 1930’s, states that the Dow Jones Transportation average is a key barometer to the future condition of the economy and the stock market. 

How It Works

We are going to construct a simple model based on North American Class 8 truck demand. We will take the peak month in the last two upcycles and then measure how long it took after that peak for the general economy to enter recession.

I know this model is so simple that a fifth-grader can understand it, but I like simple models and it does have logic behind it. Truck demand is very cyclical and the economy is also.  Therefore if truck demand is a leading indicator, it should always hit a peak before the general economy.  It also makes sense that trucks haul goods and if you need fewer trucks now, then you are hauling fewer goods in the future and economic growth should slow.

The Model

1. Peak Class 8 Production = October 1999
Recession Begins = March 2001
Gap = 17 months

2. Peak Class 8 Production = October 2006
Recession Begins = December 2007
Gap = 14 months

This time:
Peak Production = June 2015
Expected Start of Next Recession = August 2016 to November 2016

Because the current truck demand cycle is very similar to 1999-2000 (so far), let’s say the model is predicting a recession beginning in Q4 this year.  Hang on, we are about to go right into the Danger Zone.

Monday, March 7, 2016

Officially (by me) a Manufacturing Recession

The term “manufacturing recession” started appearing more frequently in economic articles and discussions beginning last October.  It is an odd expression from an economist’s standpoint.  If the entire economy were in recession, then it would just be a recession.  Consequently, for just a manufacturing recession to exist, the non-manufacturing segment of the economy would have to be growing enough to offset the manufacturing slump and result in a positive GDP number.

This is entirely possible because manufacturing now makes up only around 12% of economic output, while consumer goods and services are 70%.  However, manufacturing recessions are still rare since most of the time the manufacturing and the consumer sector of the economy move somewhat in sync. You would also not expect a manufacturing recession to last an extended time period.  Either the consumer sector would weaken, resulting in a standard recession, or manufacturing would recover and “rejoin” with the rest of the economy.

In addition, manufacturing recessions would tend to be mild.  Any significant downturn in manufacturing would probably lead the economy into a recession and, while the consumer sector and manufacturing can move in opposite directions, the gap between them will not be wide for very long.  Therefore, “manufacturing recessions” should be short and mild.

The term caused a vigorous debate in our recent FTR internal economics meeting.  Somebody asked if the economy was in a manufacturing recession, and we had problems answering that question.  It was pointed out that a manufacturing recession is more severe than a slowing in manufacturing growth.  We all agreed the manufacturing sector had been slowing for several months.  We also agreed that we would not use the term “manufacturing recession” because we could not define the term.

That worked fine for a few minutes, until someone used the term again and the debate started all over again.  I then offered a definition for “manufacturing recession” which I will share with everyone here.

Manufacturing Recession Defined

A manufacturing recession occurs when the PMI Manufacturing Index (Institute for Supply Management) is below 50 for six consecutive months, and during a time that GDP is not negative for two consecutive quarters (the standard definition for an economic recession).

The manufacturing PMI is one of the most accepted measurements of manufacturing activity.  Readings above 50 indicate expansion and those below, contraction.  The index is reported monthly and thus very easy to track.  The reason for the six-month time period is that it corresponds to two quarters of GDP, the recession yardstick.

Where Are We?

Here are the PMI readings for the last six months: 

September = 50.0 (equal to no growth)
October =     49.4
November = 48.4
December = 48.0
January =      48.2
February =    49.5

Therefore, by my strict definition, a manufacturing recession will be declared if the manufacturing PMI is below 50 in March.  But because there has been no manufacturing growth since August, I am going to invoke the “horseshoes and hand grenade rule” and say, yes, we are in a manufacturing recession. And
kudos to the people proclaiming in October and November 2015 that a manufacturing recession had begun; they turned out to be correct!

What about GDP?

For a manufacturing recession to occur, GDP cannot be negative for two consecutive quarters.  This would happen when non-manufacturing is growing and manufacturing is moderately declining, and we would expect GDP to be positive, but weak.  The current 2015Q4 estimate of 1.0% clearly fits the criteria.  The WSJ Economic Panel is forecasting 2.0% for Q2.  Based on the current manufacturing data, the Q2 estimate would appear to be a bit too high.

However, based on this Q2 GDP forecast, the PMI rising two straight months, and the February number at 49.5, it appears that manufacturing will begin growing again in March, and the “manufacturing recession” will end.  The FTR freight forecasts do not show manufacturing getting much better for the rest of 2016, however.  Truck freight growth is forecast to grow an anemic 1.3% this year.  

If manufacturing is able to contribute, even moderately, to GDP, it would indicate that we can make it through 2016 without a recession.  However, the economy will not have much momentum entering 2017, as this long, slow, extended recovery will eventually have to run out of steam.  

 This post first appeared on the FTR website.  FTR is the leader in analyzing and forecasting the commercial transportation industry.  For more information on FTR reports and services, please click here.)