US equities gave up most of their earlier gains on Tuesday afternoon, suggesting that investors remain worried about a sharp slowing of global as well as US growth.
Major indices had gained more than 1% at the high but closed with moves of +0.5% to -0.7%, hardly a recovery after the decline of the past several days. Bond yields rose marginally, and the US yield curve remained inverted between 3-month bills and 10-year notes. They’re right to be worried, in my estimation.
US consumer behavior is notoriously hard to forecast, and that leaves a giant question mark over the 2019 outlook. But Tuesday’s report on consumer sentiment from the Conference Board contained an important clue. The data strongly suggest that the December-January plunge in the year-on-year change in retail sales and the unexpectedly weak February jobs report are two sides of the same coin.
US consumers believe that the job market six months ahead will weaken, and reduced spending accordingly. That’s the hinge on which the US economy turns, given the continuing weakness in capital investment.
Two organizations, the University of Michigan and the Conference Board, poll US consumer sentiment each month, and publish a set of gauges about consumers’ view of present and future conditions. I looked at the correlation between each of these indices and the year-on-year rate of change in US retail sales, and found that one index had strong predictive value for retail sales. That is the Conference Board’s index of consumer expectations about the job market six months ahead.
Consumers’ view of whether jobs will be plentiful in six months dropped sharply at the end of 2018 along with retail sales. Those were the main data points that Fed Chair Jerome Powell cited in his press conference last Wednesday to justify backing away from interest rate increases and reduction in the Fed’s securities portfolio. In fact, consumers’ perceptions of a slowing job market were borne out by the near-standstill in February hiring, when US establishments added just 20,000 jobs compared to a monthly average of around 200,000 during the past two years.
The Conference Board’s index of consumer views about the job market six months’ hence has predictive value for retail sales with lags of zero to three months. I used this relationship to generate a forecast of retail sales, and it explains the December plunge in year-on-year growth in retail sales reasonably well, as the chart below indicates.
What’s happening to the job market? As I explained on March 8, employment growth in February fell the most in labor-intensive, low-wage industries like leisure and entertainment and health care, where the pool of available workers was shrinking and wages were rising. Contrary to the Fed’s earlier expectations, businesses didn’t adjust by increasing prices (which the Fed wanted) but by reducing new hires. During the past year, small businesses created more than 100% of all new jobs in the US. Exchange-listed companies, that is, reduced employment while small companies hired aggressively.
That appears to have hit a wall at the end of 2018. The National Federation of Independent Business index of small business future hiring plans dropped sharply at the end of 2018. As the chart shows, the two-month decline in the hiring-plans index was the second-steepest on record, exceeded only by the decline in November 2008, at the height of the global financial crisis.
The Conference Board’s employment expectation index is the last piece in the puzzle, and one that fits in with all the other observed data. Small businesses did all the hiring and more during 2018, but they are tapped out. They can’t find workers for the business in which they predominate (for example, leisure and entertainment) at wages they can afford to pay.
Does that mean the US is likely to suffer a recession this year? I doubt it, although it can’t be ruled out. The much-commented-upon inversion of the yield curve has in the past preceded every recession (and once or twice predicted recessions that didn’t happen).
The shaded areas on the above chart show recessions. When the blue line (the 3-month Treasury bill yield) touches the red line (the 10-year Treasury yield), it means that investors are willing to accept the same yield on a ten-year bond that they can obtain on a three-month bill. That happens when they expect interest rates to fall in the future and want to lock in a fixed yield now. And interest rates fall when the economy is weakening.
More likely, I think, is economic growth of 1.2% to 1.5%, not a recession but a big drop from last year’s 3% growth. That would imply a slight increase in the employment rate. It also implies a squeeze on corporate profit margins, made worse by weak growth overseas.