Last May, after the "harsh snowfall" of Q1 crushed US GDP (when it was really the bursting of China's shadow banking bubble) leading to sellside analysts first, and then the Bureau of Economic Analysis to decide the time has come to double seasonally GDP data to avoid such embarrassments as a negative print in the middle of a recovery, Bank of America's chief economist Ethan Harris rushed to declare victory.
Explicitly targeting the "perma-bears" this is what Harris said:
Perma-bears come out of hibernation: In what seems like an annual rite of spring, perma-bear economists have come out of hibernation, declaring a rising risk of recession. After all, they argue, GDP probably dropped in 1Q, and a variety of other key indicators point to recession risk, including credit and sales variables and the Treasury yield curve. We don’t buy it. We believe the 1Q GDP data greatly exaggerate the weakness in the economy and only a very selective reading of the data signals a significant recession risk.
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A favorite perma-bear approach is to troll the news for indicators that “have never been this weak outside of a recession.” Let’s look briefly at our three favorite nuggets from this data mining exercise
- Wholesale sales plunged 4% YoY in March and that only happens in recessions. The problem here is that petroleum and petroleum products make up about 10% of the wholesale sector, so the entire drop in the nominal value of sales is due to the drop in oil prices.
- The National Association of Credit Management shows a huge plunge in “credit rejection.” Actually this one component of a broader survey. The overall diffusion index is 53.9, consistent with moderate growth.
- The yield curve has flattened and is headed toward inversion. Such an inversion has preceded seven of the last seven recessions. In reality, even at its flattest point this year the spread between 3-year and 10-year Treasuries was 95bp. That is not even below its historical average. Moreover, bond buying by central banks has turned this recession indicator upside down. A flattening can be a sign of more aggressive QE (domestically or globally) rather than a sign that the market expects weaker growth.
Of course, in retrospect - now that US manufacturing is in a recession which is spilling over to the services sector - we now know that all the indicators the "perma-bears" were looking at were very much spot on, but in any case, here is Harris' conclusion:
Looking ahead, it is much too soon to declare victory, but we expect the data to improve in the months ahead as seasonal and other distortions fade.
Good thing he did not declare victory, because just about 8 months later, the same Ethan Harris overnight released a note in which he admit this:
At the end of 2014 we were anticipating a mini-revival of growth in 2015 and 2016 as domestic headwinds faded. In particular, we argued that improving balance sheets suggested the post-crisis “rehab recovery” was over and that the run-up to the presidential election would mean fewer austerity and brinkmanship shocks out of Washington. Over the past year, however, a series of shocks have undercut that optimism.
But.. but... who could have possibly anticipated these "shocks" which BofA lays out as follows:
- The drop in oil prices has triggered a faster collapse in mining investment than expected. The offsetting stimulus to consumer response from lower gasoline prices has been weaker than expected. Lower oil prices are not bad news for growth as many in the markets seem to assume, but they are not much of a net stimulus either.
- The sell-off in the high yield sector has been worse than expected. Michael Contopoulos, who was already negative on the sector, sees further challenges in 2016. Overall, there seems to be some tightening of credit.
- We also take to heart some of the concerns from our equity analysts on the machinery sector, capex investment, and weakness in rail transport data, What they are seeing seems weaker than the official data.
- The markets have gotten into a very negative mood around China and oil. In the past high oil prices were bad news; now low prices are allegedly bad news. Until last summer, the market generally ignored the slowing in China; now China is a major source of concern. In “New Year hangover” we argued that some of the concerns are overdone and we expect fundamentals to trump fear over time. However, the repeated corrections in the equity market and the very negative commentary in the business press have likely caused some sustained damage to consumer and business confidence.
... oh yes, those pesky perma-bears, who actually looked at all economic indicators, not just the ones goalseeked to validate some initial (and erroneous) hypothesis, that's who.
What does this delayed realization that it was very wrong about the US economic growth prospects mean for BofA?
- With continued weak data and confidence shocks from capital markets, we are lowering 2016 GDP growth forecast from 2.3% to 2.1%.
- We have marked-to-market 4Q GDP, adopting the 0.6% reading from our tracking model. Most of the cuts over the course of 2016 are in cap ex. In particular, we now expect nonresidential structures investment to fall 0.5% this year after a 1.2% drop last year
Then there was this:
Our judgmental probability of a recession starting in the next 12 months has risen from about 15% to around 20%.
But before "permabears" do their own victory dance on the grave of BofA's now defunct permabullishness, here is the piece de resistance:
If this were the end of the story, with weaker growth we should be also forecasting a smaller drop in the unemployment rate, less inflation pressure and slower Fed rate hikes. However, as we have discussed in recent weeks we have become increasingly pessimistic about potential growth and this week we are cutting our forecast for potential growth over the next 5 years from 2.0% to 1.7%.
"Perma-Bears" 1 - Bank of America 0.