I saw some fascinating economic research from Bespoke Investment Group on Monday afternoon that I wanted to share with you.
The analysts observed that the Industrial Production report for the month of April, published on Friday, showed a decline of 0.3%, which was notable in that it represented the fifth straight monthly decline in this indicator. IP is a key component in the checklist of the National Bureau of Economic Research, which is the official arbiter of when recessions start. That means economists have to pay attention to the indicator.
With that in mind, Bespoke analysts looked back through history to find prior five month losing streaks in IP to see where each one occurred relative to recessions. The chart below, created by Bespoke, graphs IP dating back to 1919. The gray shading represents recessions and each section of red indicates a streak of five or more straight down months in IP.
As you can see, the two have been highly correlated. Every occurrence of a five-month losing streak was accompanied by a recession and all but one recession was accompanied by a streak of five or more consecutive monthly declines in IP. At first glance, the Bespoke analysts argue, this appears to be a very ominous signal.
So what does this tell us about the current period? While the relationship between five-month declines and recessions is alarming, there are a number of important caveats, the analysts point out.
For starters, IP measures activity in the manufacturing sector, and that sector's weight in the overall economy has steadily declined over time. IP covers activity in the manufacturing, mining, and utilities sectors -- a set of sectors that have seen their overall weight in GDP almost cut in half from a peak of 32.4% in 1953 down to 16.3% in 2014, according to Bespoke data.
While weak exports due to the strong dollar and the crash in energy prices have hurt the manufacturing sector, the rest of the economy has fared better, the analysts go on to observe. While the ISM Manufacturing index has seen a sharp decline from 57.9 down to 51.5 in the last six months, the ISM Non-Manufacturing index is up over that same time period (56.9 to 57.8). When oil prices plunged last year and the dollar jumped, it was expected that some areas of the economy would benefit while others lost -- and the action in the ISM indices shows that.
A second difference between the current and prior streaks is the magnitude of the recent decline, which has been relatively mild, the analysts point out. Of the five monthly declines in this streak, two were originally reported as positive numbers before being revised lower. All in all, IP in the current streak is only down 1.0% from its high, whereas in each of the prior streaks IP was down a median of 6.26% after the fifth down month with the smallest decline being 1.5%.
To be sure, recent U.S. economic data has been a great disappointment. What economists had shrugged off as a temporary weather-related issue is proving to be more of a slowdown. Yet Bespoke analysts argue that that it's still too early to extrapolate the current five month streak of declining IP and say it is the beginning of a recession. And I agree. Ominous, yes. An immediate red flag, no.
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