VIPs
- Since ISM New Orders is a cyclical indicator, it doesn’t plateau for long lengths of time; downside risk has risen given the first quarter’s tariff-fear-induced artificial supply build at the same time private supply outpaced private demand and temp employment weakened
- Given building imbalances, odds are in favor of a second-quarter inventory correction as inventory run-off results in reduced ordering; over the next several months, ISM New Orders are at risk of falling below 50 from March’s expansionary reading of 57.4
- After a brief bounce, a quartet of Federal Reserve District surveys’ inventory expectations have weakened anew signaling further weakness; the Future Inventories series leads New Orders by about two months, so caution is dictated even if today’s report doesn’t miss
- The durable goods report contrasts year-over-year trends in new orders versus inventories from the primary metals industry; this spread has been inverted for months substantiating that New Orders for primary metals have pulled back
- While it may take months to know if ISM New Orders experiences a soft or hard landing, the surfacing downside risk suggests volatility will pick up in commodities, emerging markets and high yield trading as these asset classes carry a higher risk profile
Sorry, Isaac Newton, in some cases, the law of gravity doesn’t apply. To wit, one would think that with the exertion of pulling against gravity on the climb up a mountain, it would be easier coming down. But gravity still seems to have the last laugh. While climbers may think they’ve snatched victory from the hands of a peak upon reaching its summit, most mishaps happen on the descent. In 2017, a team from the University of Innsbruck in Austria analyzed the causes of 5,638 falls reported to the Austrian Alpine Police over the prior nine years. They found that three-quarters of injuries were incurred coming back down the mountain.
Financial and economic accidents are also more prevalent when things are going down. One of the biggest collective up-days for the U.S. economy took place three months ago today. On February 1st, the two most influential economic indicators – Nonfarm Payrolls and the Institute for Supply Management’s (ISM) Manufacturing New Orders index – posted huge upside surprises. According to Bloomberg surveyed economists, this double-dose of relief effectively stopped rising recession risk in its tracks, capping the 12-month forward probability at 25%.
Three months to the day later, the S&P 500 will open at record highs. Its mirror image, the short VIX trade, is back and better than ever. As for recession fears, the risk today emanates from Germany. Record Chinese stimulus has stabilized its economyand the hope is China’s transmission mechanism is powerful enough to rescue Germany’s ailing export sector. It gets even better. Investors are also betting that the bluest of blue chip leading indicators, ISM New Orders, will navigate a soft landing.
Surprise, surprise! It takes more than just good looks to sway us. First, ISM New Orders is a cyclical indicator. That means it’s never on a permanent plateau for lengthy periods. Second, there are signs that a down cycle is underway in the current quarter on the backside of two first-quarter developments — the tariff-fear-induced artificial supply mountain during which time private supply ran ahead of private demand.
These imbalances have set up an inventory correction in the second quarter. Building less supply translates into ordering less. There’s a real risk ISM New Orders fall below 50 into contraction from March’s expansionary reading of 57.4. Timing such a move in a monthly read is hardly an exact science. But we feel now is the right time to raise it on our – and your – watch lists for at least the next three months.
The three indicators contrasted against ISM New Orders (red line) above speak to this narrative. They illustrate emerging weakness in world trade, future supply expectations and a supply-demand discrepancy at the start of the production process.
According to the CPB Netherlands Bureau for Economic Policy Analysis, world trade volume is contracting on a 12-month basis. The December decline (-1.5%) was the weakest in nine years and coincided with the abrupt fall to 51.3 in ISM New Orders. A second year-over-year decline in February suggests sustained downward pressure. Combining 81 countries’ exports and imports into this tell-all measure, this data set has earned its status as the benchmark for global trade flows.
If cutting future supply is the order of the day, you lighten your order book. That’s exactly what we’re seeing in a quartet of Federal Reserve District surveys’ inventory expectations, which have decidedly downshifted. This forward-looking foursome was a precursor to December’s drop in ISM New Orders. After a brief quick bounce, this signal is flashing further weakness. The Future Inventories series leads New Orders by about two months, so the flag will remain raised even absent a downside surprise in today’s report.
Hard data on supply and demand for primary metals substantiate a slowdown in New Orders. This is where it all starts, with primary ingredients such as steel, aluminum and copper. The blueline is a spread sourced from the durable goods report and contrasts the year-over-year trends in new orders (demand) and inventories (supply) from the primary metals industry. The March spread is inverted (there’s that word again) to the tune of -6.6% and the inversion has been in place for four months running (that’s a fact).
We would be remiss if we didn’t add that temporary employment is critical to the current discussion in that temp positions track the inventory cycle. Temps peaked in December and losses ensued in two of the three months ended March. The American Staffing Association’s Staffing Index presaged the turn in temp jobs and has continued to weaken through April.
We won’t know if ISM New Orders experiences a soft or hard landing for months to come. The key is being prepared for the resurrection of financial volatility when the downside surprise does hit the wires. Assets the farthest out on the risk spectrum – Commodities, Emerging Markets and High Yield – are the likeliest to sustain injuries on the dangerous descent.