Today the National Federation of Independent Business (NFIB) released their Small Business Optimism Index.  While the index had a slight dip this month, it remains near its record high.  It is likely this is the bullish slant you will read about today.  However, for those of us data nerds who knows the gold lies buried deep, there is an ominous warning underneath the headline data that is important for bankers to be aware of. 

As all of us know, positive earnings and cash flow are very important for loan performance.  Back in 2016, I introduced to you the "Small Business Profit Indicator" developed by Rcube.  This is a great model for getting a sense of the likely future direction of small business profits.  As you can see in the chart below, for only the 5th time since 1984, my revised version of this model has issued a profit recession warning.  In my opinion, this is a solid confirmation of the sudden and dramatic drop in stock prices we have seen recently.  Has the market priced in enough?  It certainly got the Fed's attention, does it have yours?

If you look back over the last few blog posts, you will see I have been talking about being keenly aware of changes in your environment.  There are some very important financial indicators bankers should always pay attention to, in order to help them navigate this challenge.  Back in September, I posted a blog post about the most important sign to watch for, an inverted yield curve.  When the curve inverts, it is rarely a good sign for the future of the U.S. economy.  Unfortunately,  there are now  portions of the yield curve that have inverted.  A curve inversion, accompanied by other warning signs (such as bear markets) REALLY needs your attention.  Since September, we have had two bear markets begin; one is stocks and the other in bonds.  The S&P500 has fallen 20.21% peak-to-trough since September and at the same time, bond yields have fallen 20.06%.  Why?

Below is my weekly economic model.  It contains some very economically sensitive daily and weekly data inputs that have a high correlation with economic activity.  As you can see, it is now negative and at its lowest level since 2007.  This likely highlights what bonds and stocks are reacting to.  This is a very important development in my opinion.  



I have highlighted times in the chart where this model has been flirting with/gone negative.  As you can see, the Fed responded to these weaker economic conditions with EASING monetary policy, not tightening.  I will be focusing on my longer-term models for confimation of this model's message.  This model is alerting us to a potentially dramatic economic slowdown in the next couple of quarters.  Will it evolve into something worse?  Will the Fed continue to tighten monetary policy in the face of these headwinds?  These will be big discussion topics at April's ALMEdge User's Conference.  Keep an eye out for registration materials and hope to see you there!  

There is an old adage in economics that says, “Economic expansions don’t die of old age.”  Heck, the San Francisco Fed even did a study in 2016 on the topic, aptly titled: “Will the Economic Recovery Die of Old Age?”  Their conclusion: “Expansions, like Peter Pan, endure but never seem to grow old."  If this is indeed the case, how do we know when an economic expansion is about to end?  The same way we know when our time at the driving range needs to end, maybe we run out of balls to hit or we run out of daylight.  In other words, we run out of vital resources.

According to my research, the US economy is no different.  When we analyze the resources used to fuel an economic expansion, like employees, profits, production capacity, debt, etc. we can get an idea of what might be left to prolong an economic expansion.  The chart below provides a relative look at economic resource utilization, and according to it, we may be getting close to tapped out for this expansion.


 
Not only are business resources getting scarce, but the same may be true for the consumer.  There seems to be no shortage of opinions out there about the impact of rising rates on our economy and more importantly, the consumer.  I have always said the rate of change of interest rates is a much more important measure than the absolute level of interest rates.  When we do the same relative analysis on taxpayer’s interest expense burden, as we did for resource utilization above, it becomes very apparent that rates have risen high enough, relative to the size of outstanding debt, to start to crimp the consumer.  They may be running out of resources as well.


 

So far, this is the 4^th longest post-war expansion for the U.S economy.  While it may be true that expansions don’t die of old age, they can surely die by running out or resources, and it is becoming more evident we are reaching that point.