This Economic Indicator Says to Tread Carefully

Editor's note: Today, we're breaking from our usual fare to cover one critical reason why it's time to be selective as an investor. In this piece, Joel Litman – founder of our corporate affiliate Altimetry – highlights an indicator you should be watching right now... And he reveals why it means many industries are already vulnerable.

The outlook isn't great for a lot of industries right now...

This week, the Institute for Supply Management ("ISM") announced its Purchasing Managers' Index ("PMI") rating for April. The index measures how strong manufacturing activity is in the U.S.

A PMI rating below 50 indicates economic activity is shrinking. April's rating was 47.1... And while that was better than expectations, it marked the fifth consecutive month of contraction.

Demand has been slowing. And companies are beginning to react. They're producing less... and some are even cutting their workforces.

The PMI levels are only the latest in a string of economic difficulties...

Businesses are feeling the pressure of rising interest rates. The possibility of a recession is increasing by the day. The bank panic in the middle of March didn't help matters.

As we'll explain today, though, PMI isn't the only sign that economic growth has been slowing down. Another key data point is flashing red today – and for many businesses, this one-two punch could mean serious trouble ahead...

Corporate investment is one of the most important signs of a healthy economy...

To track this metric, we look at something called commercial and industrial (C&I) loan growth.

Companies use C&I loans to fund capital projects instead of relying on cash flows. So C&I loan growth can tell us a lot about corporate investment and the corporate outlook.

At its heart, economic growth is powered by credit cycles. When credit is freely available and anyone who needs a loan can get one, it's easy for companies to refinance and borrow for growth. That leads to strong gross domestic product ("GDP") growth and a bull market.

On the other hand, when credit tightens and demand is declining, the economy contracts.

C&I loans tend to drive economic activity. The market often follows it closely. That's what happened in every major bear market over the past 30 years.

In 1990, 2000, 2008, and 2020, C&I loans declined. And in each of those years, we saw recessions at the exact same time. Declining loans had ripple effects across the economy. Take a look...

As you can see, the S&P 500 Index closely tracks C&I loan growth activity.

And it goes both ways... When C&I loan shrinkage bottoms out, it's an equally important signal. That's when the economy goes from a consolidating bear market back to a bull market. We saw this in 1994, 2003, 2010 to 2011, and in early 2021.

Current C&I loan growth is sending negative signals...

Right now, C&I loan growth is rolling over again for the first time since early 2020.

In the first three months of the year, C&I credit contracted a little less than 1%. Loan shrinkage has only been that bad (or worse) about once every six years for the past two decades... about as frequently as you see a recession. In the middle of last year, loan growth reached 4% per quarter.

In short, companies are no longer looking to invest. That's why we don't think the recent PMI data is a one-off. It's part of a bigger story... The economy is in a slowdown.

Until credit availability improves, those PMI trends aren't likely to rebound. Production will stay lower until corporations regain confidence and banks make it easier to access credit again.

Inventories will continue to dwindle. Employment in sectors that rely on manufacturing may suffer... And that's a good reason to remain cautious and tactical in this range-bound market.


Joel Litman

Editor's note: Joel called the Great Recession in June 2008, mere months before the most devastating financial crisis our country has ever seen. Now, he says what's coming next will shatter the expectations of many investors. A market event is coming that has historically triggered major volatility in dozens of impacted stocks. So, on Wednesday, May 10, Joel is going public with the full story... and the steps you should take – right now – to avoid dramatic potential losses. Get the details here.