Michael Hartnett, chief investment strategist at Bank of America, is fully aware that difficult weather in the U.S. Northeast depressed economic activity, but he is nonetheless extremely concerned about the American economy and the S&P 500 for the remainder of the year. Two forward-looking indicators support his concern.
In a recent research report, Mr. Hartnett wrote, "Annualized gains in global stocks of 21 per cent and the U.S. dollar of 30 per cent [year to date] are too high … no one is positioned for the U.S. consumer to stay weak … . Volatility, cash and gold are likely to perform well short-term if, as we expect, the dollar and stocks pull back."
The strategist pointed to a significant uptick in the U.S. inventory-to-sales ratio as reason for concern. In strong economies, the inventory-to-sales ratio is low as manufacturers struggle to keep up with strong demand (and higher revenue). But Mr. Hartnett noted that this important indicator is "currently moving decisively in the wrong direction, a negative for production and profit."
Higher inventory levels signal slower economic activity in the future as production slows to allow stored goods to sell off.
The manufacturing new orders metric is arguably the most widely used forward-looking economic indicator for the simple reason that orders for goods translate into the production of goods. But like the inventory-to-sales ratio the trend in new orders is moving the wrong way.
The lower chart shows the year-over-year growth in manufacturing orders has declined from 8.3 per cent in September of 2014 to a highly mediocre 2.2 per cent at the end of February, 2015. New order growth averaged well more than 10 per cent in 2011 but has been stuck in a minus-5-per-cent to plus-7-per-cent range for the past three years.
The depressed levels of the Citi U.S. Economic Surprise Index (not shown) – which measures U.S. economic data relative to consensus economist forecasts – shows that the weakness in American activity is broadly disappointing. The index currently stands at minus 53 when a reading of zero would indicate that data was reported exactly as expected.
Economists still project strong 2015 gross domestic product growth of 2.9 per cent and have merely used bad weather as an excuse, in my opinion, to cut first-quarter growth estimates and raise second- and third-quarter expectations to compensate. First-quarter GDP growth has been slashed from 2.8 per cent to 1.35 while second-quarter growth has been raised from 2.8 to 3.05 per cent.
We'll see. The U.S. labour market continues to improve and wage growth, which could very well increase broad consumption levels and economic growth, are inching forward.
But for now there is little or no evidence of a U.S. manufacturing renaissance or a broad economic acceleration. Investors should limit investments in cyclical, economically sensitive U.S. companies until more confirmation of a strengthening economy arrives.
Follow Scott Barlow on Twitter @SBarlow_ROB.