As the sweltering summer hits its peak in North America, the days feel longer and the sun shines ever brighter. Cold, sweet lemonade is a favored refreshment at ballparks and swimming pools alike, often enjoyed during yard work or any time a cool drink is needed to stave off the heat.
The economy, after experiencing a decade of growth, also seems to be bracing for a slowdown. Current reports on second quarter earnings from S&P 500 companies present a mixed picture. Particularly in the manufacturing sectors, such as materials and industrials, earnings are facing double-digit declines.
The primary reason for this downturn in earnings is the contraction in manufacturing. For instance, the Chicago Purchasing Managers’ Index (PMI) plummeted to 44.4, marking the second lowest reading since the Great Financial Crisis.
For context, a Chicago PMI score below 50 signals a contraction in the manufacturing sector for that region. So far this year, the PMI has dropped in five of the last seven months. Compounding the issue is the decline in demand and production, which pushed employment indicators into contraction for the first time since October 2017.
This downturn in manufacturing isn’t isolated to the Chicago region. Recently, it was reported that the U.S. Manufacturing PMI fell in July to its lowest level since September 2009, with employment also declining for the first time since June 2013. What’s behind this trend?
Economic Lemons
An illustration of these economic troubles can be found in the auto industry. Car dealerships are reporting fewer buyers, which leads them to order fewer vehicles from manufacturers.
The inventory at dealerships is piling up, as they simply lack the space for the cars already on hand. The auto industry, comprising automakers, parts manufacturers, and dealers, employs over two million individuals. A decline in car demand directly impacts the associated jobs.
This surplus of vehicles amidst dwindling buyers is termed a supply glut in economic parlance. Reducing prices could potentially alleviate this excess supply, but if prices must drop below the cost of labor and materials, deeper issues arise.
Finding a way to turn these economic lemons into lemonade is typically unattainable. Nevertheless, many companies attempt this by increasing their debt levels. Meanwhile, major banks, bolstered by the Federal Reserve, continue to extend credit to sustain the illusion of stability.
The total nonfinancial corporate debt in the U.S. amounts to about $10 trillion, roughly 48 percent of gross domestic product (GDP). This figure has risen approximately 52 percent since its last peak in the third quarter of 2008, when corporate debt stood at about $6.6 trillion, or 44 percent of 2008 GDP. Corporate debt is now at record levels and is outpacing economic growth.
At this stage of the economic cycle, corporations have amassed so much debt that they find themselves in a perilous situation. A slight economic slowdown could spell disaster for many overleveraged businesses, leading to a backlog of defaults akin to discarded furniture lining the dry LA River bed.
Do You Hear a Bell Ringing?
While Main Street appears to be cooling, Wall Street remains unusually buoyant. The promise of low interest rates from the Fed has driven stocks to new heights, with the S&P 500 index up over 17 percent year-to-date.
However, uncertainty crept into the markets on Wednesday. Following the July Federal Open Market Committee (FOMC) meeting, Fed Chair Powell announced a 25 basis point cut to the federal funds rate. Yet, rather than hinting at more rate cuts to come as Wall Street had anticipated, Powell described it simply as a mid-cycle adjustment, suggesting a lack of a clear strategy.
This left Wall Street questioning whether further rate cuts were on the horizon or if the Fed would maintain its current stance, resulting in a 36-point drop for the S&P 500 by day’s end.
After digesting the Fed’s ambiguous stance overnight, traders opened the following day ready to seize opportunities, initially buying into the dip with confidence. The S&P 500 rose 33 points—but then, around midday, an unexpected event occurred.
President Trump, in a tweet, caused a stir by announcing:
“…the U.S. will start, on September 1st, putting a small additional Tariff of 10% on the remaining 300 Billion Dollars of goods and products coming from China into our Country. This does not include the 250 Billion Dollars already Tariffed at 25%.”
This statement sent Wall Street into a frenzy, resulting in a 68-point drop for the S&P 500, closing the day at 2,953.
The old saying goes, “No one rings a bell at the top of the market.”
What should we make of the events of this week? There’s certainly a sense that we’re hearing a bell ringing. Are you listening?
Sincerely,
MN Gordon
for Economic Prism
