An economist friend of mine from Canada sent me a very interesting article earlier this week. It discussed a data point I haven't paid much attention to previously, but one that is increasingly important in our technology-driven economy - B2B data.
The author, Mark Skousen, may sound familiar to you given an article I wrote previously discussing the "Skousen Index." To wit:
"[Dr. Mark Skousen stated] The reality is that business and investment spending are the true leading indicators of the economy and the stock market. If you want to know where the stock market is headed, forget about consumer spending and retail sales figures. Look to business spending, price inflation, interest rates, and productivity gains."
Skousen is correct. The real economy, and one that delivers real levels of higher employment, wage growth, and economic stability, is driven by the "production" side of the economic equation. Individuals must produce first to have income with which to consume. Therefore, if you want to measure what is happening in the actual economy, measure what businesses, and the factors that directly affect them, are doing. If we combine those factors into a single index we see the following:
The Skousen index suggests that the current economy is significantly weaker than headline statistics state. However, Dr. Skousen's latest discussion on B2B Data is equally important.
"Gross Output (GO) is a measure of sales or receipts of all industries throughout the production process, including business to business transactions (B2B). Most B2B activity is left out of GDP statistics which is a big part of the economy.
B2B activity actually declined significantly in the first quarter. According to the new Skousen B2B Index, business spending fell 2.8% to $22.7 billion in nominal terms compared to the 4th quarter."
While consumer spending remained fairly stagnant, driven primarily by sharp increases in health care related spending driven by surging premiums, B2B spending has fallen markedly. Historically speaking, and as shown by the chart above, B2B spending has been a good indicator of where the economy is headed. This is because it measures spending through the entire supply chain.
So, what is the B2B spending data suggesting to Dr. Skousen?
"The GO data and my own B2B Index demonstrate that total US economic activity has slowed significantly, and dangerously close to going into another recession."
Yesterday, the Federal Reserve once again postponed lifting interest rates in the hopes that economy and labor data will strengthen in the coming months to allow for a tightening of monetary policy. As I discussed previously in "Who's Right: Commodities Or The Fed," there is a clear signal being send currently. To wit:
"The Federal Reserve raises interest rates to slow economic growth to keep an economy from overheating which would potentially lead to a sharp rise in inflationary pressures. Since commodities are the basis of everything that is bought, consumed or other utilized; if there were indeed inflationary pressures on the rise commodity prices should be on the rise. As shown, this is clearly not the case."
"In fact, declines in commodity prices have historically been associated with declines in economic activity as shown in the highlighted boxes. While not every decline in commodity prices led to a recession, and I am not making that case, there is a high correlation between the ebb and flow of commodity prices and economic activity, as would be expected."
I reiterate this point because Peter Tenebrarum wrote an excellent piece of commentary yesterday making a similar connection back to the stock market and the deterioration of internals.
"The deterioration in market internals is e.g. evident in new high/new low ratios that are inconsistent with a market making new highs, and a growing divergence between prices and advance/decline statistics. Also, an ever smaller percentage of stocks remains above important moving averages. Below is a chart depicting several of the most widely followed market internals (high/low percent, advance/decline line, S&P 500 stocks above 200 day and 50 day EMA)."
"What this essentially tells us, is that capitalization-weighted indexes are held up by an ever smaller number of big cap stocks. A the time of writing, a strong short term rebound in the stock market is underway. However, the underlying problems with trend uniformity and internals depicted below remain in place.
A large proportion of the stocks holding up the cap-weighted indexes are technology stocks, which is actually an additional warning sign. At the peaks of 1998 (ahead of the Russian/LTCM crisis), 2000 and 2007, a handful of "horsemen" from the technology universe were the very last stocks to make new highs – it seems to happen every time."
A major reason for the deterioration in internals is the economic weakness currently spreading in China, coupled with malinvestment on a grand scale in the commodities sector over previous years. This combination is putting pressure on commodity prices and the energy and materials sectors have entered bear markets as a result. These two sectors together currently represent 15% of the market capitalization of the S&P 500 Index. Transportation stocks have begun to sag as well and have been in a downtrend since the end of last year"
While the media and Wall Street remain markedly bullish on the economy and the stock market, there is an ever-growing breadth of data that reflects characteristics only observed near previous major market and economic peaks.
Confidence Or Lack Thereof
This disconnect between Wall Street "euphoria" and "Main Street" economic reality can be clearly seen by the latest Gallup economic confidence poll.
The latest poll, for the week of July 26th, showed that 23% of Americans said the economy was good or excellent, compared to 32% rating it as poor. As for the future, 39% said the economy is improving, while a majority 57% said things are getting worse.
"Though Americans' confidence in the national economy has skewed negative for six months now, the recent drop of the current conditions component comes on the heels of a new path for solving the Greek debt crisis and amid a tumultuous period for Chinese stocks," Gallup's Justin McCarthy said. "The instability abroad could be fueling Americans' doubts about the health of the U.S. economy, not to mention that the Dow closed lower several days in a row last week."
This data also confirms the sharp decline in consumer confidence which recently dropped sharply to a 10-month low as well.
Importantly, all of these measures suggest the very long expansionary period in the economy may be coming to an end.
This is not a "horrible" thing. It is not a "bearish" thing. It is just a "reality" thing. While monetary policies and governmental interventions can certainly extend and prolong these cycles, such policies can not repeal them entirely.
Since there is a high correlation between downturns in the economy and the financial markets, these are data points that are worth watching closely in the months ahead.