Economic Risk Factor Update: January 2020

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Jan 14, 2020 1:38:52 PM

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My colleague Sam Millette, senior investment research analyst on Commonwealth’s Investment Management and Research team, has helped me put together this month’s Economic Risk Factor Update. Thanks for the assist, Sam!

The economic data released in December came in mixed. Improvements to service sector confidence and the continued un-inversion of the yield curve were offset by a slightly weaker-than-expected jobs report and disappointing consumer confidence. Despite the mixed nature of the reports, overall the economic data released during the month points toward continued slow growth as we kick off the new year.

The Service Sector

economic risk factor

Signal: Yellow light

This measure of service sector confidence improved by more than expected in December, increasing from 53.9 in November to 55 in December. This result was better than economist estimates for a move up to 54.5. This is a diffusion index, where values above 50 indicate expansion. So, this improvement is quite welcome, especially given the weakness we’ve seen in manufacturer confidence to end the year. The combined measure of manufacturer and nonmanufacturer confidence sits at levels that have historically indicated 1 percent GDP growth. This is the third month in a row where the index has bounced off the recent low. As such, we are keeping this signal at a yellow light for now, but removing the tinge of red.

Private Employment: Annual Change

economic risk factor

Signal: Yellow light

December’s employment report came in slightly worse than expected, with 145,000 new jobs added against forecasts for 160,000. This number was disappointing following a much better-than-expected result in November, when 256,000 new jobs were added. November’s result was boosted by the return of roughly 40,000 General Motors employees following the end of their strike in October. But even with this onetime boost, November showed the overall health of the jobs market. We moved this indicator to a yellow two months ago. Given the mixed results we’ve seen since then, we will leave it at yellow for now as the annual change continues to slowly decline.

Private Employment: Monthly Change

economic risk factor

Signal: Yellow light

These are the same numbers as in the previous chart but on a month-to-month basis, which can provide a better short-term signal.

Month-over-month job growth was positive again in December, despite the miss for the headline figure. The headline jobs number was still positive, and the underlying data was mainly encouraging as well. Unemployment remained steady at 3.5 percent, which ties a 51-year low. Underemployment also fell to a post-recession low of 6.7 percent. Although December’s headline jobs creation figure came in below expectations, the pace of new job creation clearly accelerated thought the second half of 2019 after stagnating to start the year. Given the increased pace of job creation in the second half of 2019, we will leave this indicator at a yellow.

Yield Curve (10-Year Minus 3-Month Treasury Rates)

economic risk factor

Signal: Yellow light

The yield curve continued to widen in December, as the yield on the 10-year Treasury note rose from 1.81 percent in November to 1.86 percent in December. The yield on the 3-month Treasury bill remained unchanged at 1.57 percent during the month. This marks the third straight month where the yield curve has remained un-inverted, which is how it normally functions. Despite this un-inversion, the risk of a recession in the future still remains, as historically we’ve seen recessions follow un-inversions of the yield curve within 12 months. There is also the chance that we will see another inversion in the short term, as a return to August’s recent low-water yields for the 10-year would leave us inverted. We are keeping this measure at a yellow light for this month.

Consumer Confidence: Annual Change

economic risk factor

Signal: Yellow light

Consumer confidence disappointed in December, finishing the year at 126.5 against expectations for a rise to 128.5. Despite this disappointing month, on a year-over-year basis, this result actually represents a decent reading for the index, as the December decline of 0.1 percent is the best reading in five months. Although confidence sits at high levels on an absolute basis, the continued weakness on a year-over-year basis is a concern. We are not yet at the –20 percent year-over-year decline that has historically put pressure on consumer spending growth, but future weakening confidence could get us there. We’ll continue to leave this indicator at a yellow light for now, but we’ll be watching it closely going forward.

Conclusion: Risk remains elevated

December’s data releases largely painted a picture of an economy that grew slowly at the end of last year. Given the fundamentals, we expect growth to continue at a muted pace as we start 2020. The disappointing jobs report and consumer confidence result to end the year are real risks that should be monitored going forward, as consumer spending was the major driver of economic growth in 2019. With that being said, there are still reasons for optimism. The better-than-expected improvement to service sector confidence and the continued return to normalcy for the yield curve are examples of the positive updates we received last month.

Despite these improvement on a monthly basis, the year-on-year trends indicate that risks remain. Although a continued slowdown remains the most likely case based on the data, the chances of a recession within the next 12 months cannot be dismissed. Right now, however, a slowdown is not a recession, even as the bulk of the data indicates the risks of further slowdowns remain material. As such, we are leaving the overall risk level at a yellow light for the economy as a whole for January.

economic risk factor

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