The Chicago Fed National Activity Index (CFNAI) is a monthly index designed to better gauge overall economic activity and inflationary pressure. The CFNAI is a weighted average of 85 existing monthly indicators of national economic activity. It is constructed to have an average value of zero and a standard deviation of one. Since economic activity tends toward trend growth rate over time, a positive index reading corresponds to growth above trend and a negative index reading corresponds to growth below trend. (via Federal Reserve Bank of Chicago)
Well, for the last 3 out of 4 months the Growth in national business activity is below historical trend based on the Chicago Fed’s index which comes in at minus 0.46 in June vs a downwardly revised minus 0.55 in May. The three-month average of the index at minus .60 is at its lowest level since October 2009.
Weakness in personal consumption & housing is weighing most heavily on the index followed by employment. Production & income is also a negative with sales. The only positives in the index came in the form of orders & inventories.
The overall weakness in the index is not surprising and was already confirmed by our recent update to our composite national economic output index.
The important takeaways here are several. 1) The economy is continuing to weaken despite pronouncements to the contrary by the media and economists; 2) More importantly, the long term trend in economic strength is declining as the monetary and fiscal policies of the last 30 years in partcular, which directly resulted in a credit based boom, have acted as a decay on savings, productive investment and economic prosperity and; 3) for investors, the S&P 500 is currently diverged from the direction of the economy. The companies that make up the S&P 500 are ultimately a reflection of the economy. It is only a function of time until either the market catches up with the economy or the economy catches up with the markets. I find it hard to believe it will be the later considering that the weakness accross the economic components that make up CFNAI are pervasive and weak.
The markets and the bond market in general are not reflecting a concern over a debt default. This is correct. As David Rosenberg pointed out this morning, it is highly unlikely that the U.S. will default on its debt for a variety of reasons, but most importantly, the U.S. is constitutionally bound to meet its debt obligations. Furthermore, the U.S. has a collective net worth of $80 Trillion and makes the current arguing in Washington more about politics than economics.
The thing that investors SHOULD be paying attention to is the weakness in the economy as it presents the most peril to stock prices in general. The markets are currently getting a boost from earnings season but the year over year decline in profits as well as the economy should be a cautionary flag to long term investors.
The risk to being heavily exposed to equities at the current time without some sort of hedges in place is a bold position that has the odds of success heavily stacked against it. We continue to recommend, as we have since April 25th, overweight positions in fixed income and cold hard cash until our indicators begin to turn back to positive. Remember, making up a lost opportunity in the markets is easy – making up lost principal is virtually impossible.