Back in 2009 and 2010 I penned a number of discussions regarding the macro economic and investment theme of the “Tale of Two Economies” (here and here). In short, what has been so glaring in the current cycle is the divergence in fundamentals between US small businesses and their larger globally oriented business brethren. This divergence has been most clearly seen in looking at the “rhythm” of the ISM survey set against the monthly NFIB (National Federation of Independent Business – small business) business optimism report. You can see that prior to the current cycle, these two data points were very highly directionally correlated. The current cycle has been the anomaly whereby larger business (certainly represented by the ISM survey) has done pretty darn well, but smaller firms continue to struggle.
It goes without saying that larger US companies have been the direct beneficiaries of domestic as well as foreign government and central bank stimulus. This is not the case at all for smaller businesses. But as you can see above, so the two now meet up once again. The “divergence” that has been so glaring in the current cycle appears to be closing….and not in the way most of us would have hoped. Moreover, the data point divergence “gap” between these two has come ever closer to closing completely over the last year. What’s going on here? I think there are two important messages.
Message number one is the obvious. Now that economic growth has slowed in the emerging markets and gone into outright contraction in Europe, large export manufacturers are at risk of slowing. Is Cummins a harbinger? Many have tried to explain away the recent ISM decline as “temporary”. My suggestion is that near term, the key number in the ISM report to monitor is new export orders. This goes right back to the driver of the tale of two economies theme – the ability of large companies to participate in foreign central bank and fiscal stimulus operations. Foreign stimulus that has for the most part simply bypassed the US small business community.
As you can see below, the recent ISM new export orders number has hit a level I’d characterize as pre-recessionary, if not recessionary. The folks at the ECRI, as you know, already expect the latter. Never over the period shown has this number dipped to its current level without a follow on or accompanying recession. Let’s say for now it’s in the “danger zone”.
Important message number two I believe is that the “magic” of central bank stimulus is wearing off in a big way and we can “see it” in the chart of the ISM index and NFIB optimism. Again, prior to 2009, the ISM series and the NFIB data were very highly directionally correlated. But with QE1 in early 2009, certainly accompanied by significant global government and central bank stimulus, the ISM numbers gapped up and pulled far away from the NFIB series. The “gap” at that time was very significant. Along comes QE2 and both the ISM and NFIB rise, but this time the “gap” is much smaller. Finally with Operation Twist and Europe’s LTRO both move higher in late 2011, but this go around the divergence gap is the smallest of any mini-cycle yet. The “magic” of printed money wearing off as a drug for the economic patient? It sure looks that way. For now, economic fortunes of large and small US business appear to be recoupling. We’ll just have to see where we head from here. Maybe the next QE will be different. Or not. Maybe the good news is that large and small US business future fortunes are now more in line than has been the case this cycle. But the bad news is that this is reconciling with large/multinational company fortunes dimming as the NFIB data never really truly showed us true recovery at all during this cycle.
A few final comments. There still exists one relatively large divergence between the ISM and NFIB numbers. And that divergence exists in the employment data. Again, directional correlation here has been relatively meaningful over time, but the divergence of the current cycle is plainly obvious. So, if the tale of two economies theme is slowly fading to black as per the macro headline ISM numbers and the very important new export orders level, what about manufacturing employment?
As you know, the US has experienced a bit of a manufacturing renaissance as of late. Wage levels significantly lower than the prior cycle(s), access to cheaper energy for those using natural gas as an input, and the fallout effects of Fukushima/Thailand (critical manufacturing supply chains far away now returning home) have been incrementally supportive positives. Will that continue to be the case ahead? Or will macro global economic slowing ultimately influence the direction of manufacturing employment stateside (the ISM series)? For now it’s just a question, but the answer lies dead ahead. IF ISM new export orders continue weak, it only seems common sense manufacturing employment is at risk.
Final thematic issue. THE consistently number one concern of small businesses (again as per the NFIB numbers) throughout the current cycle has been demand. You remember, the term demand is usually interchangeable with the word sales. Revenue will also do in a pinch. The chart below tracks NFIB responses to anticipated sales and pricing ability for the last decade and one half as per the US small business community. As is obvious, the data “rhythm” of the current cycle looks nothing like prior cycles.
In the recent survey, small business forward sales expectations have again turned down, much as we saw in 2010 and 2011. But this time around will reconciliation be seen with higher small business sales expectations ahead, or with lower large company sales/demand expectations ahead? Again, we’ll have an answer soon.
The “tale of two economies” is certainly not a theme about which I’ve enjoyed writing, but it has been a true reality. My suggestion is that perhaps the most important issue right now is that global stimulus is having a diminished impact on real economies with each iteration. Personally I have been wondering if the eventual Fed QE3 will play out along the lines of the Facebook IPO. In one sense, Facebook peaked before it even came public because of way too much anticipation and hype. So too with QE3? Stay tuned.
