Amid a multi-month string of positive data surprises – which was mirrored by an improved sentiment towards US assets - and especially following the change in seasonal adjustment factors for data referring to January 2012 onwards – as published by the US Department of Commerce on Wednesday – the near-term risks for negative data surprises have increased substantially. I expect US economic data referring to January and especially to February to disappoint on average! However, it does not alter the medium term trajectory of the US economy nor change my positive view on Eurozone assets (see also 2009 all over again? dated January 23). Rather it should see speculation about QE3 in the US intensifying.
I have stated on several occasions that I think the seasonality of the US economy should have decreased but the actual seasonal factors used to adjust the raw-data have increased (see for example: Growing probability of positive US data surprises dated May 31 2011). Since the onset of the last recession in late 2007 the US economy has lost several million in manufacturing and in construction (approx. 2mln each). On the other side, employment in sectors such as healthcare (+1,5mln) has increased. While the former are highly seasonal, the latter is not. As a result, the seasonality of the US economy should have decreased. However, the seasonal factors which have been used in 2010 and 2011 assumed that the seasonality of the US economy has rather increased! The reason for this is that the seasonal factors are calculated via statistically analysing historical data. The sharp slump in GDP following the bust of Lehman Brothers took place in autumn and winter. Given that this period is the seasonally weak period of the year anyhow (with January being the weakest month), the statistical techniques resulted in larger statistical factors. This can be seen in the chart below which shows the seasonal factors used to adjust the raw data of the ISM manufacturing index.
Seasonal Factors used for the US manufacturing ISM index: higher seasonality in 2011?
Source: ISM, ResearchAhead
The factors for 2007 are shown in blue, those for 2011 in grey and the difference between the two in red. As can be seen, in 2011 the period from November to March (i.e. those months where the financial crisis in 2008/2009 led to a stand-still of global trade) was assumed to be significantly weaker than in 2007 (the seasonal factors are lower). On the other side, the seasonal factors for April-August assumed that the economy would be showing more momentum in 2011 than in 2007. Hence, the seasonal factors assumed in 2011 (and 2010) that the US economy’s seasonality increased significantly. As a result, the published seasonally adjusted data painted too positive a picture for data relating to the November-March period and too negative a picture for the April-August period. I think it is no coincidence that the US stock market topped out in spring 2010 and 2011, i.e. just as the period of artificially positive data came to an end. Furthermore during both years it bottomed in summer, i.e. just as the period of artificially weak data was about to end.
However, yesterday, the US Department of Commerce published the seasonal factors to be used for the calculation of the manufacturing and non-manufacturing ISM indexes in 2012. It stated that: “In response to concerns that the unusually large declines in autumn 2008 associated with the recent recession that may not have been adequately handled with default settings, this year the Department of Commerce used lower thresholds (critical values) for detecting outliers. “
Seasonal Factors used for the US manufacturing ISM index: lower seasonality in 2012
Source: ISM, ResearchAhead
As a result, the seasonal factors which are to be used for this year’s ISM releases have been changed materially as the chart above shows which compares the factors for 2011 and 2012. Especially the seasonal factors relating to January-March have been increased significantly (and those for May-October lowered significantly). In turn, the seasonal factors have moved closer again to where they were before the financial crisis.
The result though is significant. For today’s release of the January ISM index, the difference between the 2011 seasonal factors and the 2012 numbers amounts to approx. 0,6 points in the headline number (i.e. the 2012 number should be 0,6 points lower, all else equal) and a full 2 points for the February release! The difference is the largest for the New Orders component where the seasonal factor rose from 0,944 in 2011 to 0,999 in 2012 which depresses this sub-component by approx. 3 points! For the non-manufacturing index, the January 2012 numbers should be 1 point lower than in 2011 purely due to the change in the seasonal factors.
Given that US economic data has surprised positively in the second half of 2011 (see chart below for the Citigroup US economic surprises index), sentiment towards US risky assets and economic forecasts have improved also. However, coupled with the changes in the seasonal factors, this should lead to a significant downside risk in economic data over the next weeks, starting with data relating to January and intensifying for data relating to February!
US Citigroup Economic Surprise Index: multi-months positive surprises should by now be reflected in improved forecasts