Why is the Stock Market Ignoring Signs of a US Economic Slowdown?

The stock market appears to be ignoring signs of a US economic slowdown.   December Retail Sales were a disaster, but more importantly Unemployment Claims are rising and Manufacturing Output -- particularly auto assemblies -- took a hit in January.

The market's seeming lack of reaction to bad macroeconomic news is parallel to its failure to be boosted by good macroeconomic news in Q418.  In both cases, the market focused on the outlook rather than current conditions.  And, shifts in Fed policy and Trump's stance on US/China trade negotiations changed the outlook from being negative in Q418 to being positive now.

Another way to view the change is using an "optimal control" perspective.  This perspective says the financial markets tend to move in ways consistent with the Fed's goals.   In Q418, the Fed was tightening, saying the growth outlook was too strong to prevent inflation from picking up.   As a result, stocks fell and longer-term Treasury yields rose, working to slow the economy.   In January, the Fed backtracked, emphasizing downside risks to the outlook.   So, stocks rose and longer-term yields fell -- moving in directions  that would lift economic growth ahead.

There are three ways the current market moves can end, if not reverse.   First, the Fed could be slow to react to increasing signs of slower US economic growth.  It would suggest officials are comfortable with the slower pace.  Second, US economic growth could speed up, making a boost from the financial markets unnecessary.  Third, the stocks could overshoot on the high side and pull back.

Right now,  evidence of weaker economic growth has grabbed the headlines.  Although the extraordinary plunge in December Retail Sales received the bulk of attention last week, the more troubling piece of data was the increase in Unemployment Claims.  They represent the most significant evidence so far that US economic growth is slowing.

The drop in December Retail Sales cannot be easily explained.   The Commerce Department said the government shutdown did not affect the collection or processing of the data.  Possibly retailers had problems reporting the data.  Or, possibly people who were out of work either directly or indirectly because of the shutdown stopped buying goods or going to restaurants.  There could be other, technical factors behind the plunge, as well.  Presumably, part of the sales plunge should show up in a jump in retail inventories (due March 11).  In the meantime, the Atlanta Fed model's projection of Q418 Real GDP Growth is now down to 1.5% from 2.7%, due to the Retail Sales data.

If the plunge in sales was one-off, it will reverse in January.  This would result in sharp volatility in the q/q GDP growth rates, making an average of Q418 and Q119 Real GDP Growth the more accurate measure. 

The Claims data, however, suggest at least some of the December weakness in Retail Sales was not temporary.  Claims should now be falling if their recent run-up stemmed from the government shutdown.  Instead, both Initial and Continuing rose in last week's report, keeping them well above the Q418 average.   In contrast, Claims came off their winter highs in February 2018, signalling a post-winter speedup in Real GDP Growth.  This year, there is no such evidence from Claims.

                                            Unemployment Claims
                         Initial (000s)                        Continuing (Mn)
                       2019        2018                       2019       2018
     Q4             219          238                         1.63        1.91            
     Jan             220         234                          1.71        1.95
     Feb            237         221                          1.77        1.91
     Mar           na            228                          na           1.86
     Q2            na            223                           na           1.76

Weakness in the manufacturing sector was likely at least partly responsible for the recent increase in Claims.  Friday's January Industrial Production report showed an overall softening in manufacturing output, led by a drop in motor vehicle assemblies.  Motor vehicle sales also fell that month, so the cut in output may be more than just a temporary inventory correction.

The February Employment Report, due March 8, could be another important clue of an economic slowdown.  Payrolls could slow sharply if some of the January job surge was due to the mild winter.  An unwinding of a weather-related jump in January Payrolls tends to show up in March, however.