A Look Around the US Economy

Stocks had a rough day Tuesday, and the alleged culprit is one we have seen with increasing frequency lately: A raft of good-looking economic data supposedly raises the likelihood of more big Fed rate hikes to come. This is part and parcel of a sentiment phenomenon we call the “pessimism of disbelief”—investors’ tendency to see any good news through a negative lens. It is a hallmark of late downturns and early recoveries, and its prevalence today is a big reason we think this downturn’s end is likely close by. When people dismiss good news as bad, it shows a big gap between sentiment and reality—substantial room for positive surprise. What did people overlook in the latest data? Read on!

Durable Goods Orders Look Pretty Durable

The week started with May’s advance durable goods report, released Monday. It showed total orders for goods designed to last three years or more rising 0.7% m/m, beating expectations for no change and accelerating from April’s 0.4% climb.^[i] Core capital goods orders (non-defense ex. aircraft), which are widely considered a proxy for business investment, grew 0.5% m/m—their third straight rise and an acceleration from April’s 0.3%.^[ii] Now, this corresponds only to the equipment portion of business investment, which is only about 40% of the total—commercial real estate and intellectual property products (e.g., research & development and software) hold big sway, too.^[iii] And these figures aren’t inflation-adjusted, which is an important caveat. But the resilience of a major category is still noteworthy, as it occurred against the backdrop of rising rates—a factor people have worried would derail investment for months.

Those worries always struck us as overwrought. To date, the prime loan rate is up 1.5 percentage points this year.^[iv] If an investment in capital equipment’s long-term return would be destroyed by that small an increase to borrowing costs, then it likely wasn’t a wise investment to begin with—and probably wouldn’t have happened. Now the data are starting to bear this out. Also positive? There isn’t much evidence that the inventory cuts that dragged down Q1 GDP were the start of a longer cycle of businesses getting lean and mean—if it were, we would probably start seeing that here. Instead, businesses remain expansive. That cuts against fears that a recession is underway already, in our view.

Taking Stock of Inventories

Speaking of inventories, Tuesday brought news that wholesale inventories jumped 2.0% m/m in May, adding to April’s 2.3% rise.^[v] Retail inventories also rose, up 1.1%.^[vi] This might seem to indicate a turnaround in inventories’ contribution to GDP, which was a drag in Q1. Yet monthly inventory measures were also positive throughout Q1, making their negative contribution a surprise. So we think it is premature to conclude that a rush to replenish stockpiles will boost Q2 GDP. (Here, too, take note: The data aren’t inflation-adjusted.)

At the same time, we see other potential interpretations—some good, some bad. On the potentially negative side, for those who fear companies are overstocked, a continued inventory rise could indicate a mounting overhang that will require deep discounts to clear later. That could theoretically weigh on production in the period ahead. But that is only one possibility—and perhaps a positive development in the eyes of some, to the extent discounting could help tame inflation, which would help quell a major fear weighing on markets this year. Or, for those who worried rumors of overstocking were greatly unfounded and supply chain issues were still rearing their ugly heads, then positive inventory data could provide some relief by showing goods are still flowing from factories to vendors.

If you find this choose-your-own-adventure approach frustrating, we hear you—but that comes with the territory when trying to analyze inventories. They are always open to interpretation. Rising inventories could indicate businesses racing to get ahead of expected demand—or they could indicate a building supply glut. Falling inventories could signal supply chain problems, businesses’ cutting bloat, or production not quite keeping pace with outsized demand. The answer is only ever clear in hindsight, which is why we don’t lean on inventories as a forward-looking indicator.

Preliminary Trade Data Don’t Suggest Recession, Either

Tuesday’s other big release was the advance report on May trade, which showed exports rising 1.2% m/m and imports falling -0.1%.^[vii] Considering net trade (exports minus imports) detracted from Q1 GDP as exports fell and imports rose in that quarter, May’s report might seem good from a GDP-math standpoint. But it isn’t adjusted for inflation, and it includes trade in goods only. Broader data including trade in services will be more telling, but those won’t hit until July 7.

Then again, we think GDP math gets it wrong, as it treats imports as a drag even though they represent domestic demand. If you are a major retailer, chances are you import a large portion of your inventory. So if imports are down, that probably means you hit tough times. Therefore, in our view, the correct question to ask is whether a slight slide in goods imports represents falling demand.

It might—but there are reasons to think otherwise. As you may have read, the dollar is at its strongest level in years versus major global currencies. That means every dollar spent abroad buys more than it used to. It is entirely possible that the US imported more stuff—a higher volume of goods—but spent slightly fewer dollars to do it thanks to the dollar’s strength. It is also possible that the stronger dollar offset inflation in other countries, keeping overall trade volumes flattish. The US, unlike Japan and the UK, doesn’t produce trade volume indexes—these gauges measure just the values—so we can only guess. But in a world where people are determined to find the cloud in every silver lining and couch every positive economic report as bad news, we think the mere existence of possible positive interpretations is an unsung good. It raises the probability that reality is better than feared, even if just modestly so.

As for whether these stronger-than-feared data put the Fed on a more aggressive tightening path, we won’t opine. Divining what the Fed may do beforehand is a futile exercise, one that would require knowing how the Fed is interpreting all the incoming data. As shown, that is far from clear.