More disappointments likely on the way

Things are probably going to get worse before they get better. Data releases published today showed that by certain measures, economic activity in the fourth quarter weakened in the U.S., fueling more concerns about slowing growth and adding to investor anxiety. More importantly, the data suggest that this trend is likely to continue into the months and quarters ahead as exhibited in three data releases today: 1) business investment, 2) professional forecast data and 3) mortgage originations.

First, durable goods orders — a key measure of business investment activity — unexpectedly weakened during the first month of the fourth quarter even as expectations were set for the effects of the 2017 Tax Act to boost spending. A more detailed line item of this measure which excludes defense and aircraft spending suggests slower U.S. economic growth to come.

Why is this backward looking data important? We believe this is because the indicator has been shown to be predictive of economic activity by 2-3 quarters, depending on the time period observed. Extrapolating the relationship from current trends suggests slower GDP growth through year end and into the first half of next year.

Indeed, the Atlanta Fed’s closely watched GDPNow indicator of economic activity suggests that growth in the fourth quarter is tracking at 2.5% given today’s weaker durable goods orders data. This is lower than the 3% projected by the same model at the beginning of November. Much of the slower growth comes from lower household spending (PCE) and business investment activity projected by the leading indicator.

Further adding insult to injury was more data showing lower mortgage originations, particularly among home refinances, which is reflective of weakness in the housing market that we’ve been writing about. We believe that one catalyst to the downturn in housing is related to lower affordability as mortgage costs are on the rise. Today, the average 30-year mortgage is well above 5% even as the average yield on 10-year Treasuries has fallen back near 3%.

Today’s softer reads for October, combined with other measures of economic activity that we’re tracking suggest the US economy is likely to continue weakening, not strengthening in the near term. This trend in economic data is likely to add to and not take away from current levels of heightened market volatility as investors position themselves for more downside risks.

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