Strategic Global Intelligence Brief for December 14, 2018
Short Items of Interest—U.S. Economy
Rethinking Fed Strategy
There has not been a new position staked out by the Fed at this point. However, economists are busy reading the tea leaves and consulting their Runes as they look ahead to 2019 and what Fed policy might look like. The expectation earlier this year was that 2019 would look a lot like 2018 with three, or maybe four more rate hikes. That is no longer a safe assumption as there appears to be less urgency around inflation than was the case earlier. Despite the record low levels of unemployment, there has been little wage inflation. That has started to temper expectations. Few think the Fed will abandon rate hikes altogether, but now the thinking is there will be a cooling off period lasting a few months into the new year. At this point, we have not heard how the Fed feels about this.
Trade War as Biggest Risk
With some of the traditional problem areas easing a bit, the attention of analysts has focused on the risk of a real trade war between China and the U.S. As noted above, the inflation concern has faded a bit—at least for now. There is still concern over the impact of high debt and deficit, but these are like chronic diseases that one learns to live with. Now the threat is a trade war. There are several angles to consider. The U.S. farmer will lose a major export destination and there are other sectors of the U.S. economy that will miss that market. Importers will either have to hike prices or find a new supplier. That will hurt consumers. The bigger issue may be that countries doing business with both China and the U.S. will be caught in the crossfire and will suffer economically—hurting their ability to import from the U.S.
Bad News on the Deficit Front
It seems neither Democrats nor Republicans care about the size of the debt or deficit these days. Thus, the problem is accelerating. The deficit for the first two months of fiscal 2019 was over $300 billion. That is $100 billion more than the deficit that was run in the first two months of fiscal 2018. The deficit is on a pace that will break records. The tax cuts were supposed to goose the economy enough that revenue would flow in to replace what was lost to the cuts. It has not even come close. Meanwhile, Congress has stepped up spending.
Short Items of Interest—Global Economy
Saudi Arabia Rebuked
Congress has apparently had quite enough of Saudi Arabia and has passed a couple of measures that make this abundantly clear. There will be no further support for the Saudi war in Yemen (a largely symbolic move). That opens up a very slim possibility for a truce. This is now an utterly shattered nation that is starving to death and has been relentlessly attacked by Saudi air strikes made possible by the U.S. In the same breath, Congress has rebuked the crown prince for his role in the murder of Jamal Khashoggi. Relations between the U.S. and Saudi Arabia have not been this bad since the days of the Arab oil embargo, despite President Trump's attempts to smooth things over.
EU Rejects Prime Minister May's Plea
Prime Minister Theresa May managed to survive a no confidence vote that would have ended her government and forced new elections, but she is no closer to solving the Brexit mess and now knows there is no support for the deal she struck with the EU. She has reached out to Jean-Claude Juncker to see if there is a chance for modification and has been utterly ignored. The EU has no interest at all in making life simpler for the U.K.
Stimulus Falls Short in China
It had been assumed the Chinese could jump start the economy with some government help—it has always worked in the past. This time it has not been enough to counter the issues that have slowed the economy this year. The biggest concern has been the trade and tariff war, but there has also been the slow realization that China has a labor shortage problem that stems from an aging population.
Latest Set of Readings Start to Look a Little Bleak
What follows is the executive summary of a report we do for a pair of industrial organizations: the Chemical Coaters Association International (CCAI) and the Industrial Heating Equipment Association (IHEA). Both are in the metal business and represent a wide range of manufacturing operations.
There is a little something for every taste in this month's report. There were as many down readings as there were positives. They rather conveniently fell into two broad categories. If you are thinking that next year will be a nice continuation of the growth in 2018, there is something in this data to give you some confidence. However, if you are of the opinion that 2019 heralds an end to the nice run we have had since the recession, there is plenty to worry about. The feeling in the air is that something is going to break in the coming months—either due to the interest rate policies pursued by the Fed or a reaction to tensions in the global economy. There is also the sense that the next two years will be the most vicious yet as far as politics is concerned. The slim chances for some kind of bipartisan progress vanished with the division of Congress into warring camps.
The five readings that are trending down are pretty closely related—cause for some ongoing concern. The first of these is the capacity utilization number. It has not fallen far, but it has been frustrating that the numbers can't seem to jump into what is generally considered normal territory. It had been expected that capacity utilization would have reached 80% by this point in the year. There was also a rather steep decline as far as Purchasing Managers' Index (PMI) new orders were concerned. The total PMI has been doing reasonably well with readings still in the mid-50s (anything above 50 is expansion), but the new orders data had been as high as 70 just a year ago and has since fallen to about 55. This is clearly still growth, but nothing like it has been. There were also steep drops in both durable goods and factory goods. It is not the time of year one would expect this.
The slowdown in durable goods looks to be related to the slowdown in the housing sector—especially the building of multi-family units. That pace has slowed and so has the pace of starter home construction. The other durable goods areas that have been affected include the agricultural sector, but the good news has been coming from the oil and gas community as they have been investing again. The decline in factory goods this time of year suggests retailers are not rushing to replenish their store shelves. They chose an inventory light approach that relies heavily on early sales and discounts and seem willing to leave money on the table rather than get stuck with unwanted inventory. In lock step with all this other distress, there was a slump in the transportation index as the trucking sector has not seen consistent demand from retailers. The parcel carriers are doing fine, but that is part of the reason stores are not. The demand is not there and stores are just not loading up anymore. It has been noted that most stores have already abandoned their Christmas and winter inventory.
The good news is more scattered. There was a minor uptick in the sales of cars and light trucks, but for the most part this sector has been consistent for the majority of the year—not bad when considering that many analysts predicted a big drop earlier in the year. The housing sector bumped up a little, but still remains lower than it had been earlier in the year. The bloom is most definitely off that rose. Steel consumption has been up. Much of this still seems related to stockpiling in anticipation of tariffs and trade wars that do not seem any closer to resolution. The prices of metal have come off the bottom, but they are still very low. It doesn't appear that demand is going to spike in a way that boosts these prices. None of the industrial commodities are seeing consistently higher prices as has become evident from watching the volatility of oil prices. The rate of capital investment has trended up very slightly, but most had expected a more robust reaction by this time. It has been a good year as far as rates are concerned. The market has been lively which should have given cap-ex activity a bigger boost. Finally, there was the better news coming from the Credit Managers' Index. Even this, however, has some caveats to consider. The favorable readings like dollar collections were up along with sales and new applications, but the unfavorable numbers didn't improve—that means accounts out for collection and bankruptcies and slow pays.
The month actually seems to feature more bad news than good, but this is best seen as a temporary reversal as opposed to a full-on recessionary slide.
PMI New Orders
The PMI New Orders Index is plunging and far faster than the overall PMI. It is important to remind ourselves that even with the decline of the last few months the overall numbers are still good—mid-50s. That is still a far cry from the nearly 70 mark that was hit just last year. Since that point, there has been a steady decline in the new orders numbers. The new orders data is the more predictive part of the PMI and tracks the level of new business. It is early days yet, but the decline has now been showing up for a few months in a row. That has some assuming 2019 will be somewhat slower than was 2018. The other sub-index readings from the PMI have been holding fairly steady including the reports on employment and exports. The overall PMI has been sitting in the 50s, but the upward movement that had been evident in the past year has not continued at the same pace.
Durable Goods Shipments
There has been deterioration in the durable goods numbers this month, but they remain higher than they have been in much of the last year. The decline may be attributed to some seasonal factors such as the early arrival of winter and bad weather in much of the country. This had an impact on construction-related equipment as projects shut down sooner than has been the case in prior years. There has also been a slowdown in multi-family construction. That affects everything from appliances to the equipment needed to do this building. The consumer has backed off on the purchase of cars and entertainment vehicles like boats and off-road gear. The agriculture sector has been hit hard by low farm prices and more expensive inputs so the appetite for new farm gear has been limited. There has also been a little bit of a lull in demand for new aircraft.
The track of factory orders was dramatic, and certainly not in a good way. This month's plunge took away all the gains that had been made in the previous four. Now the numbers are back to where they were in July. This kind of decline is bad enough, but the timing is also causing concern. If anything, there should be a surge in factory orders given the time of year. It seems retailers are not planning to budge from the strategy they established at the start of the season. The assessment of consumers was that they would not be able to sustain their pattern of spending through the rest of the year. That prompted the retailers to go into the holidays in an "inventory light" position. They have been doing this for the last few years, but analysts had thought better consumer confidence numbers would persuade the merchants to go back to old ways.
The pattern this year, as it has been in most of the last few, is to front-load the holidays with big sales and discounts so as to get the consumer dollar first. This also means that when the original inventory has been sold, there is no effort to replace it. The retailer would rather leave money on the table than have to deal with unwanted inventory. This affects factory orders as there is no incentive to produce to meet this late demand.
The level of cap-ex has been stable now for several months. The latest data shows a little bit of a gain. However, it is not substantially different from the readings that had been noted over the bulk of the last year. The activity in cap-ex often parallels the activity as far as productivity and the readings on capacity utilization; there have been similarities. The surprising aspect of this data is that conditions would suggest that this kind of investment would be warranted right now. The interest rates are still low but clearly going up. While the trade wars are rearranging relationships and supply chains, it would seem that now would be a good time to invest on the assumption that conditions will only get progressively worse. This reaction has not been manifesting at this point, but it is possible there will be renewed interest if the Fed raises rates early in 2019 along with the rate hike expected at the end of this year.
The consumption of steel has been surging over the last few months. There has been a combination of traditional motivation and more unique factors. The two biggest markets for steel have been vehicle making and construction (mostly in the public and commercial sectors as opposed to residential). The relative stability of the car and truck market has helped with consumption numbers, but it has been noted that cars and trucks have far less steel in them than was the case 20 years ago. The construction sector tends to run hot and cold. Lately, it has been slightly more active as some of the infrastructure efforts have been underway. A third area that affects demand is the oil and gas sector. This has been booming as the U.S. continues to move up the ranks as an oil producer and exporter.
The impact of the steel tariffs is still being felt. There have been many twists and turns in this saga and more are expected. In the beginning, there were tariffs on all imported steel regardless of where it came from. Then, almost every exporter to the U.S. was exempted (all but Russia, China and Japan). Later, the tariffs were imposed on all the exporting nations again. Then, an exemption was given to South Korea and Brazil—the second- and third-largest exporters to the U.S. With the completion of the U.S. Mexico Canada Agreement, it is assumed that both Canada and Mexico will soon get exemptions. They are the No. 1 and No. 4 exporters of steel to the U.S. The average price hike has been 40%—rather than the 25% that would cover the tariff.
New Home Starts
The housing sector has been struggling over the past several months, but has shown a little bit of life in the last few weeks. There has been a more definite separation evident through the last year with a marked slowdown in the construction of multi-family units and starter homes, while the more expensive homes have continued to see solid demand. As with anything else dealing with real estate, the location factors are key. There are still many hot markets where demand outstrips the availability, but there are also many markets where the housing stock is abundant. The overall price of homes has been going up steadily. There are several reasons for this movement. At the top of that list is the higher costs of building as most of the inputs have been experiencing price hikes. This has ranged from lumber to steel to dry wall, textile, appliances and so on. The mortgage rates have been rising as well. That means higher down payments. There has been a consistent shortage of skilled workers which has jumped labor costs and delayed much of the construction. Finally, there is the demand factor in those hotter neighborhoods. The competition for available homes drives up the price.
My Extremely Unscientific Uber Poll
It was one of my habits to chat with the taxi drivers I encountered to get their take on the state of the local economy and things in general. That became increasingly unproductive as very few of the drivers knew enough English to engage in commentary. Those that did were reticent to opine as they were foreigners and somewhat suspicious of my motives. Now that I have abandoned the taxi industry in favor of the ride share world, I am back at it. This is utterly anecdotal. I make no assertion that it is representative. There are, however, a wide variety of drivers involved with Uber these days and I meet quite a few of them,
I usually start with some generic comment about how busy the roads are. That generally triggers a comment on how much a given town has grown and where. I next follow up with the question of how long they have been doing this and what their motivation was. The vast majority assert it is schedule flexibility that most appeals. Most see this as a second job. I have seen a lot of fire fighters and police driving Uber, as well as stay-at-home mothers, students and shift workers. There are lots of retired folks driving as well. When our conversations turn political, there is a theme. In short—it is "a plague on both your houses." They seem to reflect an attitude I see in many others. They are sick of political squabbling and games—they want people who actually want to accomplish something for the public and they do not see many with that aim. They have become increasingly irritated with the mindless drivel of social media as well as the media coverage given to stuff that simply doesn't matter to anyone.
Transportation Activity Index
This is one of the charts we provide to CCAI and IHEA. It is derived from a proprietary system we developed a number of years ago to monitor the transportation sector. This is a sector that is often looked at as a harbinger of things to come for the economy. In the activity index, we look at all the modes of transportation (trucking, rail, parcel, ocean, air, etc.) and we look at various industry drivers such as fuel costs. It has been a very prescient index and has tended to reflect the actual performance of the overall economy. It is based on the same diffusion index used by the Purchasing Managers' Index and the Credit Managers' Index, so right now, the numbers are still in expansion territory, but it has not been as robust as it was earlier in the year.