In September, manufacturing activity showed a modest recovery, according to a report from the Institute for Supply Management reports. The latest update of the ISM Manufacturing PMI Index indicates that “economic activity in the manufacturing sector expanded in September, following three consecutive months of slight decline.” The index increased to 51.5 last month, up from 49.6 in August. A figure above 50 indicates economic expansion, making this report relatively optimistic and a surprise for many economists.
The capital and commodity markets began the third quarter on a strong footing, with nearly all major asset classes experiencing gains in September, putting everything comfortably in positive territory for the year as of the end of the third quarter. While looking back suggests a robust performance, nostalgic views can sometimes be misleading, particularly if momentum is at risk of being replaced by mean reversion.
As we look ahead to the upcoming quarter’s GDP, I will regularly present various forecasts derived from different methods for comparison. With that in mind, let us examine how several predictions for the third-quarter U.S. GDP measure up.
● The Signal and the Noise: Why So Many Predictions Fail–But Some Don’t
By Nate Silver
Review by Burton Malkiel via The Wall Street Journal
As elections approach, the question of who will win—and by how much—becomes a popular topic. For Nate Silver, however, the art of prediction transcends mere speculation; it is, or at least aspires to be, a science. Mr. Silver is an acclaimed forecaster and the creator of the New York Times political blog FiveThirtyEight.com, known for accurately predicting the outcome of the last presidential election. Before his work at the Times, he garnered recognition for his careful analysis of often unreliable public-opinion polls and developed an innovative system for forecasting Major League Baseball player performance. In “The Signal and the Noise,” he guides readers through the landscape of successful and failed predictions across various fields while offering tips on how we might enhance our forecasting abilities.
Recent economic indicators from July and nearly complete data from August suggest a weakening trend in the economy. However, the decline is not yet at a critical level that would indicate a recession risk. The three-month moving average of the Capital Spectator Economic Trend Index (CS-ETI) has modestly decreased over the last three months leading up to August, which indicates that while we are not in a recession, caution is advised in this slow-growth environment.
The U.S. Bureau of Economic Analysis reports that personal income and spending experienced an increase in August. Although the rise in income was modest in nominal terms and showed a decline after adjusting for inflation, personal consumption expenditures had a robust month, marking the largest increase since February. Much of this higher spending can be attributed to rising gasoline prices. Nevertheless, consumers appeared willing to spend more on durable goods, indicating a readiness to invest in discretionary items. Overall, the latest figures on income and spending suggest a lingering forward momentum in the economy. Thus, there is no clear evidence pointing towards an imminent recession.
Today’s economic reports reveal a mix of positive and negative indicators. In the labor market, initial jobless claims fell significantly, declining by 26,000 last week—the largest weekly drop since July—to a seasonally adjusted 359,000. This leaves new unemployment benefit filings close to the post-recession low of 352,000 from the week ending July 7. However, this promising news is contrasted by a notable decline in durable goods orders for August. The significance of one set of data over the other will become clearer as additional figures emerge in the coming weeks. For now, we must consider these newly released statistics, which paint opposing pictures of the economy. The ultimate macroeconomic reality will unfold soon.
Surprise, once again—stocks and inflation expectations have both dropped. This has become somewhat of a trend over the past four years, beginning during a significant economic downturn when a prominent investment bank was allowed to fail, causing a breakdown in the relationship between markets and macroeconomic variables. I refer to this phenomenon as the “new abnormal,” characterized by an unusually high positive correlation between fluctuations in the stock market and inflation expectations, which are defined by the difference between the 10-year Treasury yield and its inflation-indexed counterpart. Regardless of the terminology, this correlation endures, reflecting a persistent demand for higher inflation among investors, likely continuing until the economy stabilizes to a more “normal” state. Until then, this new abnormal will persist.
If I had to pinpoint one economic indicator that concerns me the most today, it would undoubtedly be the significant drop in new orders related to business investment—specifically, non-military capital goods excluding aircraft, as reported monthly by the Census Bureau. Economists often regard this series as an important sign of future economic activity. The recent weakness in demand for capital goods raises alarms. But is investment in capital goods truly a reliable gauge for predicting where we are in the business cycle?
The potential for data revisions to disrupt even the best analysis is a significant challenge that requires ongoing diligence. However, revisions need not compromise the ability to interpret data for insights into economic direction. Although there are no foolproof strategies, several techniques exist to manage this risk and prevent a well-structured forecast from deteriorating due to unforeseen changes.
