Strategic Global Intelligence Brief for August 14, 2018

Short Items of Interest—U.S. Economy

Will Populism End the Bull Market?
The U.S. stock market is about to set an important record—it will be the longest bull market in U.S. history. It has certainly had its ups and downs, but has been exceedingly resilient as it has shaken off many of the issues that seemed poised to end the run. The investment community always manages to sound glum right in the middle of a boom, but there has been some consensus building around the biggest threat to the continuation of the boom. There is concern that too many decisions affecting the business community have been affected by the rise in populist feeling. There are worries about trade wars and the impact of tariffs. There are concerns that the president is willing to inflict significant pain on the U.S. economy if he thinks the pain inflicted on the Chinese and others will be worse. That has many investors assuming the bull market is nearing an end. On the other hand, these dire predictions have been heard before.

Fed Warns of Impact on Exports
The Fed in New York has just completed a study showing that the threatened trade and tariff war will have as much impact on U.S. exports as on imports. That will mean deficits will not dwindle much. There are two reasons exports will suffer. The first is simply that other nations will impose tariffs on the U.S. in retaliation for those the U.S. has imposed. They will be carefully chosen to hit the U.S. export sector hard. The other issue is more subtle. The U.S. manufacturer is as much an assembler as manufacturer. That means importing parts and assemblies from all over the world. Lack of access to these parts will compromise the growth of many U.S. companies. The upshot is that imports will fall, but so will exports and the trade deficit will not get any better.

Excessive Restrictions Blamed for Housing Crisis
There are many cities in the U.S. that have a chronic and serious housing shortage due to the fact it is very hard to build in these communities. There are strict zoning regulations that affect multi-family homes, green space, price and other variables. It has been referred to by critics as "closing the door behind you." People want the neighborhood they moved into to stay the same as it was when they moved in, but sometimes that was 30 or 40 years ago and the demands of the community have radically altered. On the other hand, an investment of significance was made with some assumptions. Changing rules now can be deeply resented.

Short Items of Interest—Global Economy

Turkish Business Demands Climbdown by Erdogan
The economy in Turkey is reeling and is now staring a major crisis in the eye. The currency has collapsed, which has led to massive inflation waves already. The fear is that this crisis will spin out of control and render the recovery nearly impossible. The business community is now demanding that Erdogan back off when it comes to the contest with the U.S. Trump has attacked Erdogan over the refusal to release an American religious leader that has been loosely connected to the failed coup. The demand is that Erdogan release the man and find a way to get back on decent terms with the U.S. The lira rebounded on the assumption Erdogan will listen to his business supporters.

Iraqi Frustration
The analysts have been asserting for years that Iraq makes little sense as a country as the divisions are too great. The Sunni and Shiite distrust one another and neither of them trust or are trusted by the Kurds or the Turkoman. The divisions are sharpened by the north/south divide and years of conflict. The governments that get elected do very little of what they promise. Now, voter turnout is as low as it has ever been and street protests are widespread. The specter of another civil war looms large.

German Growth Surges
The German consumer is back in the game. That has been good news for the Germans and the EU as a whole. The spending surge was not expected. It has been across the board—from big ticket items to entertainment.

The Latest from the Index of Indices
Each month, we write up a series of analytical pieces connected to some of the index information that manufacturers find interesting and relevant. We do this for the Chemical Coaters Association International and the Industrial Heating Equipment Association. Here are this month's observations. This is the executive summary plus a few select sections that make up the eleven indicators taken into consideration.

There is as much to get excited about this month as there is reason to worry. Six of the twelve indicators are trending up and six are trending down. Most of the movement is substantial as well. This has been an odd year in many respects and that trend is likely to continue for the duration of 2018 and into 2019. The one thing that most businesspeople abhor is uncertainty—at least more than they usually have to contend with. They have enough to worry about as far as keeping track of their competitors and understanding their consumers. This year they have had to deal with additional confusion brought on by governmental activity. These interferences have ranged from the trade and tariff disputes to new or different regulations to legislation affecting how and where they can conduct business. This involvement is a theme throughout this report.

Analysis: The six sectors that are trending in the direction preferred include "new automobile/light truck sales." This has been volatile for a while as the sector tried to stay connected to the demands of the consumer, but the last few months have exposed this sector to the steel and aluminum tariffs as well as ongoing threats to interfere with the import of car parts and automobiles. Despite these issues, there has been solid demand from consumers that appear to be spending that tax windfall at last. The rate of "industrial capacity utilization" has ticked back up again as many companies that bought additional machinery earlier in the year have finally been able to work these machines as intended. There has also been more real estate expansion. As is often the case, the rate of "capital expenditure" has risen along with the capacity utilization numbers. Companies that are expanding need additional equipment. As long as finding appropriate workers is an issue, there will be more investment in machinery, robots and technology. Factory activity in general has been solid as there have been gains in both "durable goods shipments" and in "factory orders." The rise in durable goods activity can often be skewed by what is happening in the aerospace sector, but this time there was a more even distribution as far as growth is concerned.

The "new home starts" was one of those factors not doing as well as hoped. It is way down. That is part of a series of indicators showing this engine of the economy is stuttering under the pressure of high prices, expensive mortgages and the fact that housing remains in short supply due the lack of skilled workers. The price of homes in the very hottest markets has started to fade a little but not universally. The "steel consumption" numbers are down now that the frantic buying of steel to beat the price hike has ended. Steel demand has also been off more than anticipated. "Metal prices" as a whole are down, which seems perplexing given the impact of tariffs on imports. The prices in the metal markets reflect the attitude of the investor more than the position of the industrial buyer. The investors remain worried about the overall state of the economy and what it will do to demand and prices.

The Purchasing Managers' Index is creaking a little, but remains robust in the mid-50s, which signals solid expansion. The "PMI new orders index" is down from earlier in the year, but is still solidly in the high 50s and low 60s. The only concern has been lower trending. The "Credit Managers' Index" has been behaving very similarly, but remains in strong expansion territory. The only worry as far as either of these readings is both are trending towards a weaker position. It is not expected to get any worse in the short term, but it is clear that the rapid growth earlier in the year may have ended. The last of the measures to give some concern is the transportation index as it has slipped ever so slightly. This is a very small shift and will have nothing to do with the viability of this sector. Transportation has been at a high level for years. Some suggest that this run will continue as the retailers move product all over the country. All in all, the data has been good and that explains the high growth numbers in the last quarter. It now seems some barriers are developing that could compromise candidates seeking work in very creative ways.

New Automobile/Light Truck Sales
The auto sector has been stared at all year—like miners eyeing that canary and waiting for it to fall silent. Thus far, the bird just keeps chirping away and reassures all who are paying attention that gas levels are not yet fatal. On the other hand, it is hard to tell if that bird is starting to feel queasy. The factors that should be affecting the auto sector have been building up through the course of the year, but they have not yet had the expected impact. The price of gasoline is up by around 50 cents a gallon from this spring, but it hasn't yet sent people careening off to buy small cars or even curtailing driving much. The automakers know that steel and aluminum prices are headed up, but thus far they are shoving that cost back down to their suppliers. The consumer continues to spend and doesn't yet seem to be that worried about inflation down the road. If they were, the rate of car buying would probably have risen by now as people would be trying to buy before prices go up.

If there has been any kind of reaction, it has been to news that a trade war with Europe might result in a severe restriction on cars coming from the EU nations as they will be heavily taxed. That seems to have jump started the demand for these European brands as people want that Mercedes, Porsche or BMW; not to mention that overwhelming demand for a new Renault or Fiat.

New Home Starts
The bottom seems to have dropped out of the housing sector at last. This may only be a temporary decline, but there have been warning signs for quite some time. They have many in the industry asserting that all those threatened headwinds are finally blowing hard enough to matter. The litany has become familiar by now. Prices have been going up steadily in all of the major markets, mortgage rates have been climbing of late, there are shortages of homes in most of the hotter markets including everything from a worker's shortage to more costly materials.

There are a couple of caveats that accompany this analysis. The housing market is vast and complex and the new homes part of it is much smaller than the sales of existing homes. The latest data on existing home sales is not showing as radical a decline, but it has been down. The other factor to note is that new homes are broken into two broad categories—single family and multi-family. It has been the multi-family segment that has been most volatile. That figures given the number of Millennials who still prefer renting to getting into their first home.

There is evidence the hottest housing markets are cooling down—at least as far as home prices are concerned. The super hot west coast markets are still seeing solid demand and some of the most popular neighborhoods are still quite expensive, but generally speaking these markets are cooler. The biggest issue for the housing sector now is the lack of skilled workers as this has slowed the pace of construction throughout the country.

Steel Consumption
The world of steel continues to be topsy-turvy. The steel tariffs have kicked in and product imported into the U.S. is running about 40% higher than had been the case earlier in the year—aluminum has spiked even further. The issue now is what type of steel a company needs. Many of the needed grades of steel are not produced in the U.S. at all. This has to be addressed by individual exemptions—a very time consuming process under the best of conditions. There was an assumption that U.S. steelmakers would swiftly take steps to supply all these needed products, but the truth is that these companies are not interested in getting burned again. They rushed to fill that void when the Bush administration tried the same tactic. When the tariffs were lifted a few years later, they were left with highly uncompetitive product.

Consumption levels are falling as users are struggling to pay for the higher prices, a trend that will only accelerate. The added pressure on Turkey of late is now hitting the rebar market as they were the primary source for the U.S. The dispute with Turkey is not even about trade. This is what is making these issues so hard to deal with. Trump has ramped up pressure on the Erdogan government because they will not release an American religious leader who had become engaged in last year's attempted coup against Erdogan.

Metal Pricing
For the bulk of this year, the price for most industrial metals has been falling. That seems a little counterintuitive given the impact of the metal tariffs. The fact is the markets for these metals are reflected as investments as compared to the price for these metals to those using them industrially. The market thinking is that higher prices for aluminum and steel will drag down demand. This will, in turn, have a more profound impact on pricing than the tariff in the future. The key to this thinking is to observe what is happening with gold. This is not an industrial metal at all and reacts purely to the vagaries of the market. Investors right now are more worried about economic slowdown than they are about inflation. When inflation is the No. 1 concern, the price of gold soars as people seek to use it as a haven. The feeling right now is that the economy may slow due to all the uncertainty around trade. That might blunt the impact of inflation as well as slow the reaction of the Federal Reserve to hiking interest rates.

PMI New Orders
The most recent trend for the Purchasing Managers' Index is not as promising as it was, but it is certainly no cause for alarm. The numbers are still in the mid-50s. The new orders index is still above 60, but not by as much as was the case a few months ago. The sense is that some of the early year enthusiasm has faded and the rest of the year will feature respectable numbers, but not the blazing readings that had been expected earlier. There is evidence mounting that third quarter numbers will be lower than the Q2 numbers—not a great surprise. The U.S. is a mature economy and struggles to maintain a pace of growth over 4%. It has only happened four times since the recession formally ended in 2009. The U.S. average is around 2.5% a year. This year it will likely finish with a 3% rate. That generally translates into PMI data between perhaps 53 and 57—roughly where the index is standing at the moment.

Intelligent Discourse
There are plenty of reasons to assume that this is a vanishing art, but if one tries to set aside the incessant noise, there is reason for hope. One of the delights from writing this newsletter every day is the opportunity to engage with so many of my readers. I feel as if I know them as friends given how much we communicate. What is even more delightful is that much of the time we disagree on some pretty major points. I have conservative correspondents that take me to task on various issues and I am just as irritating to my more liberal readers. The point is they still read what I have to say and take the time to point out my bias and my foibles. We have some very different opinions and rarely do we give them up, but we can explore those differences with respect and conclude the discussion without animus—prepared to try again to have the other guy see things our way. I may still disagree, but I am able to see their position far more clearly.

To be honest, I think there is more of this kind of discourse than we all realize. Most of us are not screamers, ready to break into a rant with the slightest provocation. We care about what happens in our world and we want to influence it in some way. Back in high school, I was something of a raving leftist (that period ended when I studied in the USSR for a year and came away a disciple of Malcolm Forbes). I had a good friend who was just as much a raving rightist. He dabbled in the John Birch Society, while I was interested in the Socialist Worker's Party. People would ask us how we could be friends with such different outlooks. We answered that at least we cared enough to have opinions—the people we could not stand were the apathetic ones.