Goldman Sachs issued a very bullish note on the Euro this morning. Not because they think Europe is entering a period of robust growth. No, in fact they reduced their estimates for European growth based on the recent Euro strength, however, they see the U.S. economy simply deteriorating more than Europe. The chart in this presentation that jumped out was the ISM’s index compared to the orders & inventories. The orders and inventories data shows a very strong leading indication of future ISM growth. Currently, the orders and inventories data is forecasting ISM readings in the low 40s. The lead time here ranges from 3-6 months so based on this data it would not be shocking to see contraction in the ISM data in the next two quarters:
David Rosenberg recently highlighted a similar chart showing that there is a 75% chance of recession when this occurs. He said:
“What is critical here is the orders-to-inventories ratio, which leads the headline ISM by roughly three months and strongly suggests that we will be sub-50 and as such ‘double dip’ talk will re-emerge before the end of the year. See what this ratio has done in recent months:
Ouch! Detect a pattern here, folks? The orders-to-inventory ratio is all the way back to January 2009 levels, when the economy was knee-deep in recession. All we can tell you is what the historical record says — at this level in the past, the economy slipped into contraction 75% of the time.”
There’s clear lag in the data above and recent ISM readings have reassured the bulls, but the leading indicators in the ISM data clearly point to a much weaker US economic environment in the months ahead. My guess is that Ben & Co. know this is the case and they’re reaching deep in the toolbox to get ahead of the problem. Unfortunately, QE is not a fix.