Tuesday, September 10, 2013

Commercial Lending Suggests Weaker Employment

by Lance Roberts

Most people have now realized that the August employment report was less than desirable.  What really surprised analysts was the disconnect between what appeared to be stronger economic reports, from the recent manufacturing surveys, and job creation.  The chart below (courtesy of Zero Hedge) is from Trim Tabs which shows the range of estimates preceding the August employment report.


With a median estimate of 179,000 jobs there were expectations that jobs would breach the 200,000 level.   The problem with these estimates, other than being overly bullish, is that the underlying economy is likely not as strong as some of the recent economic reports suggest on the surface.

One such measure of economic strength that I like to watch is "Commercial and Industrial Loans At All Commercial Banks."  If the economy is really improving, demand is increasing and employment is rising then businesses will seek, particularly in a low interest rate environment, funding for business expansions, capital expenditures and extension of credit.  The chart below shows the annualized percentage change in commercial and industrial loans as compared to economic growth.


As you can see there is a fairly tight correlation between the annual changes in economic growth and the demand for commercial loans. Just as you would expect the recent downturn in loans has coincided with the downturn in the annual rates of economic growth.  While there are many expectations that the economy is set to improve through the end of this year the decline in business loans is suggesting that this may not be the case.

The next chart compares commercial lending trends to employment.  As I stated above; if businesses were indeed gearing up for stronger economic activity in the months ahead which would lead to an increase in hiring we should be seeing a reflection of this ramp up in commercial loans.  Again, commercial loans have a strong correlation to employment and the recent decline in commercial loans suggests that the weak employment report in August, and downward revisions in the prior months, is likely more consistent with the real level of underlying economic activity.


While this is just one indicator of many that can used to evaluate economic strength the importance of commercial lending trends, as it relates to real economic activity, should not be lightly dismissed.   While the recent decline in lending activity is not necessarily indicative of an impending recession; it certainly does not suggest that stronger economic and employment growth is on the immediate horizon.

The recent bumps in manufacturing surveys are likely bounces in activity due to inventory restocking and short term pent up demand.  The sustainability of those increases are questionable given the spike in oil prices and rising interest rates which erode consumption.  This does not even factor in the potential impact of the Federal Reserve tapering off their support, potential tax increases/spending cuts from the upcoming debt ceiling debate or the onset of the Affordable Care Act in the months ahead.

For investors the point is that potentially overly optimistic assumptions on the economy, given the very weak state of revenue growth, could lead to disappointment down the road.  With recent revisions to GDP potentially masking underlying economic weakness it will be important to continue to pay attention to data that is a reflection of the "real" economy rather than a statistical one.  Such data will likely act as an "early warning" sign of issues that will potentially show up too late for mainstream analysis to be effective in hedging portfolio risks.

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