I noted at the beginning of this year the divergence between the ISM manufacturing survey and the decline in both imports and exports. To wit: "The surging dollar and weak consumer demand are also being reflected in import and export activity."

I pointed out the different trends for "sentiment-based" ISM survey’s readings and actual economic data. The suggestion then was that the surveys were going to play catch up to the actual economic activity and not the other way around.

As more recent data show, that has been exactly the case despite much mainstream commentary to the contrary.

While the surging U.S. dollar has provided a substantial drag on exports, it certainly does not explain the sharp decline in imports, which should benefit by being cheaper for domestic consumers. It is also quite the conundrum when combined with the fall in gasoline prices that, as all mainstream economists believed, would provide an additional boost to consumption.

The decline in both exports and imports is evidence that the underlying economic strength has deteriorated sharply in recent months. Both the annual rate of change in imports and exports have now moved into negative territory.

Importantly, both (on an annual percentage change basis) have now fallen below -5%. Historically, this has been coincident with the onset of recessionary periods.
The extremely sharp decline in imports suggests, despite lower gasoline prices, the contraction in domestic spending is much sharper than currently realized.

Economic Confidence Takes a Hit

The contraction in both exports and imports is the hard data behind the economy. Confidence, or sentiment, in the short term can remain elevated as individuals and businesses "hope" that recent activity will continue. Such psychological tendencies are termed "recency bias," which is when very recent events are extrapolated into the future.

Over time, sentiment will eventually catch up with reality. This is most clearly shown in the recent release of Gallup's economic confidence poll:

"Gallup's U.S. Economic Confidence Index was -9 for the week ending May 3 — its lowest weekly score since December. This reflects a six-point decline from the previous week, and is the largest week-to-week drop since last July."

"Gallup's Economic Confidence Index is the average of two components: Americans' ratings of current economic conditions and their views of whether the economy is improving or getting worse. The theoretical maximum of the index is 100 if all Americans say the economy is "excellent" or "good" and "getting better." The theoretical minimum is -100, if all Americans say the economy is "poor" and "getting worse."

“For the week ending May 3, 24 percent of Americans said the economy is excellent or good while 29 percent said it is poor, resulting in a current conditions score of -5 — down four points from the previous week and the lowest current conditions score since December. The economic outlook score saw a sharper drop of eight points, to -12 — its lowest reading since November. The latest outlook score is the result of 42% of Americans saying the economy is getting better, and 54 percent saying it is getting worse."

While the index is still above its lows of last year, the rapid decline in confidence suggests that there is more afoot than just "cold weather."

As I have stated previously, we are likely to see a bounce in economic data going into the second quarter following the sharp suppression at the beginning of this year. However, it is important to remain focused on the actual "trend" of the data rather than monthly data points. While short-term data points may show an increase in activity, it is the overall trend of the data that tells the real economic story.

Momentum Loss: Everywhere

Speaking of data trends, over the last couple of months the deterioration in momentum has permeated the financial markets globally.

Major indices covering large, mid and small capitalization stocks, broad U.S. markets, international and emerging markets show that momentum has now declined to a point that suggests weaker markets in the short term. While this does not suggest that the markets are about to enter into the next major financial crisis, it does suggest that risk currently outweighs reward in the short term.

Importantly, this loss of momentum also lines up with the entrance into the "seasonally weak" time of year. As discussed:

"May represents the beginning of the "seasonally weak" period for stocks. As the markets roll into the early summer months May, and June, tend to be some of weakest months of the year along with September. This is where the old adage of "Sell In May" is derived from. Of course, while not every summer period has been a dud, history does show that being invested during summer months is a "hit or miss" bet at best.

It is quite clear that there is little advantage to be gained by being aggressively allocated during the summer months.

Lastly, it should be remembered that the market is currently engaged in the longest bull run in history without a 10 percent correction. The decline in momentum, the weakness in economic underpinnings and lack of central bank interventions (not to mention the threat of an increase in overnight lending rates) certainly provide the necessary ingredients for a sharper than expected correction this summer.

Risk is clearly elevated, and the potential reward of being aggressively invested currently leaves little to be desired. This is particularly the case given our discussion recently on the highest level of correlation between asset classes since the financial crisis:

"The degree to which securities move hand-in-hand is measured by correlation. A correlation closer to +1 implies more of a dollar-to-dollar move in prices.”

“According to a new study from the IMF, correlations in general are much more elevated these days than they were before the financial crisis. In other words, there are fewer places to hide in the markets when the markets start tanking."

This suggests that investors trying to "game the system" with sector rotation strategies will likely be swept up with the correction when it comes. While a "rising tide lifts all boats," the opposite is also true.

There will likely be better opportunities to invest capital as the "dog days" of summer wane into autumn for those with patience and capital to invest.