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Strategic Global Intelligence Brief for January 17, 2020

By Chris Kuehl, Ph.D., NACM Economist

Short Items of Interest—U.S. Economy

Who Has the Leverage?

The trade deal signed between the U.S. and China has broken with the usual pattern of trade deals and will likely have an impact on future negotiations between nations. The system established at the end of WWII sought to balance trade talks through the use of an arbitrator who was considered neutral. The deal with China abandons that system and shifts the power to the U.S. If China does not adhere to the demands made in the pact, the U.S. can reimpose tariffs and other restrictions and the Chinese will have no recourse other than to pull out of the deal altogether. Essentially, this approach places all the power in the hands of the nation with the most leverage. In this situation, that is the U.S., but in other situations, it may not be and the U.S. will be in the subservient position.

USMCA Passes as Trade Skeptics on Both Sides Agree

After some 30 of NAFTA, it is hard to remember what the original idea was. The U.S. was worried about competing with the European Union given their ability to leverage the lower cost structure of the southern tier states such as Italy, Spain, Greece, etc. The notion was we could create our own version with Canada and Mexico. The USMCA essentially abandons that notion and looks at trade with these two with a more protective perspective. The pact focuses on issues such as labor protection, environmental protection, domestic content and restricted access to the U.S. market. It is no longer seen as promoting North America as a whole and is far less popular in Canada and Mexico.

Consumer Spending Held Steady in December

The consumer kept pace through the month of December, boding well for the coming year. It is not uncommon to see a slump in spending after the initial rush of Black Friday, Cyber Monday and all the rest. The consumer reacts to the sales and then retreats. This year, the spending stayed strong through the month (as did the discounts and sales). The big issue now is although traffic and revenue numbers remained strong, the big discounts chewed into profits, making for a less robust season in the final analysis.

Short Items of Interest—Global Economy

Chinese Slowdown

The growth in China has dipped to levels not seen in almost 30 years. The major problem has been the trade war with the U.S. and the subsequent reduction in export activity, but there have been internal issues as well. The growth rate is now at 6.1%—half of what it was just a few years ago. The government is now attempting all manner of stimulus plans, but they are not expected to have a major impact as long as the export sector is compromised. The trade deal will take some of the pressure off but will do nothing to address the issues of consumer spending or the issues in their banking system.

Collapsing Birth Rate in Europe

One of the issues that arises during periods of economic stress is women are forced to make choices regarding their family. They can either focus on having children or working. Throughout Europe, they are choosing to focus on employment. The birth rate in Italy, Spain, France and many other nations is collapsing and will have a long-term impact on a region already dealing with a rapidly aging population.

British Retail Numbers Falter

The consumer news in the U.S. has been good and it wasn't too bad in Germany and elsewhere in Europe. That has not been the case in Britain. The consumer went into retreat at the end of the season and doesn't show any signs of rebound in 2020. The expectation is that Brexit will happen and it will damage the U.K. economy. The slowdown in retail puts even more pressure on the Bank of England and Parliament to find ways to stimulate the economy, but the options are very limited at this point.

Report from the Front—A Collection of Indices

Every month Armada prepares an analysis of several indices that collectively describe the state of the economy for two manufacturing organizations—the Chemical Coaters Association International and the Industrial Heating Equipment Association. Both of these groups are oriented toward the metal industry—either chemically treating or heat treating. They are especially interested in sectors such as automotive, aerospace, appliance manufacturing and pretty much any other industry sector that deals with metal. That is a very useful cross section of the overall economy. What follows is the executive summary and select breakouts of the index analysis.

There is a good bit of optimism regarding the 2020 economy—at least at first blush. As a "dismal scientist" I can't leave well enough alone and have to mention that with the good news comes some worries about what to expect later in the year. We can start with the good news though. The unemployment rate is still very low, and there have been several months of solid job growth. The expected growth rate for the year remains close to 2%, and that is certainly respectable. It is not the 2.5%–3% that was experienced most of the last couple of years, and it is a far cry from the 4%–5% that was thrown around at the start of the Trump years. Compared to the anemic rates in Europe and developed Japan, the numbers are solid. The concerns revolve around several familiar themes—a chronic labor shortage in manufacturing, transportation, construction and even health care, worries about a return of recession in the U.S. if the global slowdown manages to infect the U.S. and the potential for an inflationary spike due to the reduction in output of key commodities. Then there is the chronic issue of debt and deficit. If one looks at the index readings collected this month it is a toss-up with six trending in a positive direction and six trending in a negative direction.

The six that are moving in a positive direction include some important indicators for the future, but there are some negative trends that might affect the rest of the year as well. The positives include new automobile/light truck sales, new home starts, industrial capacity utilization, metal pricing, appliance activity, credit movement as measured by the Credit Managers' Index and the Transportation Activity Index. The latter two readings have a history of being "canaries in the coal mine" as they react quickly to changes in economic momentum and tend to point the way for the rest of the economy later. The six that have trended in a more negative direction include steel consumption, the new orders index from the Purchasing Managers' Index, industrial capacity utilization, capital expenditures, durable goods and factory goods. There are some important themes here to pay attention to.

The common factor as far as growth is anticipation of a decent short-term trend and the existence of confidence within the ranks of the consumer. The common theme as far as the negative numbers is that these are looking out further into the future. The consumer is still in a good mood and has yet to start worrying about the possibility of layoffs or the arrival of inflation. That translates into wishing to buy cars and homes, and these indicators are therefore trending up a little. Metal pricing has reacted to the decision on the part of producers to reduce their output a little and allow prices to rise. Gold is way up in reaction to the turmoil in Iran and the Middle East. Oil prices have barely budged, and that was an unexpected development. Appliance activity has been reacting to the confidence in the consumer and their interest in buying homes or engaging in home improvement activity. The Credit Manager's Index has been improving for an interesting reason. The bulk of the good news is coming from the "unfavorable" factors. This means that there have been improvements in terms of disputes and slow pays and even accounts placed for collection. It would appear that many companies are trying to enter 2020 with a better credit situation and are trying to catch up with those they have been buying machinery and inventory from.

The negative activity is almost entirely focused on production decisions. There has been a decline in steel consumption as there has been very little improvement in the infrastructure development promised over the last few years. The numbers are down when it come to the new orders index from the Purchasing Managers' Index and this is the more forward looking of the sub-indices. The overall PMI has been in contraction territory for the last five months in a row and so has the new orders index. The capacity numbers have retreated a little, and there has been far less in the way of capital investment as one would expect when there is already slack in the system. The durable goods numbers and the factory numbers are both following suit. The sense is, that while the current numbers are good, there is limited confidence in the ability of the economy to sustain this level of activity. Election years always create uncertainty, and this one will be far more threatening than past versions. Trump is capable of drastic moves designed to appeal to his core supporters, and the Democrats have a far more "progressive" agenda which is generally hostile to the business community.

Automobile/Light Truck Sales

The automotive sector is a key part of the manufacturing community worldwide and there have been any number of controversies involving the sector and global trade. The key part of the new USMCA was the requirement that there be more domestic content in cars produced for the U.S. market (more of the assembly and more parts from the three nations in the pact). There has been a threat to cut off the European car market from U.S. access, and this would come as a major blow to a German economy already in a recession. The numbers in the U.S. have been flat for the last year but that hides some important shifts. The demand for small cars has all but evaporated as the majority of the vehicle buyers are attracted to SUVs, CUVs and trucks. There is also an ongoing concern over the driving habits of the millennial and Gen-Z. Those that live in urban areas are not all that interested, leaving Baby Boomers as the largest car-buying market. The rise of the electric vehicle has been slowed by cheap gas, and there is little on the horizon pointing to higher fuel prices. If an imminent war in Iran is not enough to cause a major jump in the per barrel price of oil it is hard to determine what would (maybe if North Dakota decided to join OPEC?).

CCAI/IHEA Indices Continued

New Home Starts

The housing market is divided in a number of ways and that always makes definitive statements challenging. There are the very obvious regional differences as there will always be parts of the country with a hot market and parts that are less than robust—often within the boundaries of a single state or community. The new home market is a relatively small part of the total as sales of existing homes dominate activity. There are multi-family units and senior living complexes and so on. The data collected on new home starts will show this sector to be most sensitive to factors such as mortgage rates and overall levels of consumer confidence. This data also tends to fall into two categories: higher priced homes and starter homes. The starter category has been the most sensitive to factors such as mortgage rates, the price of the home and consumer confidence while the higher end homes are most sensitive to the performance of the stock market. The big jump in the last month of readings is due primarily to activity in the higher-end homes. The millennial buyer is still leaning more toward the multi-family unit although those in their 30s are becoming more interested in single family dwellings as they start families.

Steel Consumption

The levels of steel consumption in the U.S. and globally depend on a handful of markets. At the top of the list is construction and within that sector the most important area is public sector followed by commercial activity. The pace of growth in housing has almost nothing to do with steel demand. The next largest category is automotive and vehicle assembly in general. After that it is a crowded field that includes everything from agribusiness to ship building and health care. The grades of steel matter tremendously as automotive doesn't use the kind of steel that hospitals and restaurants use. The greatest challenge to the steel consumption numbers has been the slow pace of infrastructure development. Much attention is lavished on the issue of infrastructure but there has been very little money allocated to new roadways, bridge repair, construction of airports and seaports and the like. This has been the main reason that consumption numbers have been uneven and in decline most months.

Industrial Capacity Utilization

The capacity utilization numbers have been remarkably consistent over the last several months as they have moved in a very narrow range between 76 and 79. This is not bad but the preferred level of utilization is between 80% and 85%. This is not something set in stone, but the sense is that when capacity usage is under 80% there is too much slack in the economy and that will inhibit acquisition of new machinery and technology as well as hiring and other expansion. When usage is over 85% there will be shortages and potential bottlenecks. There has been no threat of shortage for the last few years but there has been stubborn resistance as far as the rate moving towards normal. The sellers of machines and machine tools report that there is still demand for their output but that buyers are delaying delivery and that has started to create a cash flow issue for these companies. The good news is that companies are still planning to buy but the bad news is that they are pushing delivery off by as much as two to three quarters as they wait to see what the year looks like.

Metal Pricing

The big mover as far as the metal markets are concerned has been gold and for the most traditional of reasons. The threats of a major Middle East confrontation have propelled investors into a search for some kind of safe haven and that usually means gold. There has also been a jump in demand for currencies such as the Swiss France and the Japanese Yen. The other metals have seen demand shrink a little and that has affected their price levels. There have been no big declines, but nothing suggesting prices are headed up dramatically either. Generally pricing is lower than it was a year ago, and that seems to reflect the global slowdown in many manufacturing sectors. The producers have been reducing output in response to the reduced demand but thus far this decline in output has not triggered higher prices. The expectation is that when demand recovers there might be a period of price hikes until producers elect to step up activity to meet that additional demand.

PMI New Orders

The five-month decline in the overall Purchasing Managers' Index has been of some real concern and has been taken by some as a signal of a potential recession. It is even more disturbing that the New Orders Index has been below the 50 line since July. The diffusion index used in the PMI holds that any number below 50 is an indicator of contraction (and numbers above 50 suggest expansion). The reason the PMI is so closely watched is that the data is current and reliable. Much of the economic data is old before it can be judged accurately (it takes three or four revisions before GDP numbers or employment numbers are secure). Surveys are fast but often unreliable as people give inaccurate responses. The purchasing manager simply reports whether they are buying more or less or the same and the data is both timely and accurate—therefore a great barometer for the economy as a whole. The New Orders index is the more future-oriented part of the index, and having readings in the 40s causes concern regarding the pace of growth through the year.

Struck by a Quote

Werner Herzog is a German film director noted for the social commentary in his films. Werner Twertzog is the Twitter creation of an American literature professor named William Pannapacker at Hope University in Holland, Michigan. I ran across a quote that was attributed to Werner Herzog but was really from "Werner Twertzog," and it struck me in two ways. The quote is as follows: "Dear America: You are waking up as Germany once did, to the awareness that 1/3 of your people would kill another 1/3, while 1/3 watches." Having just read the book "In the Garden of the Beasts," that statement struck me. Germany in the 1930s was turning in on itself with deep and violent hatreds on daily display. There is a lot about our current political discourse that looks distressingly similar. I am shocked by the animosity that is now dominating society and has all but ended any sort of civil exchange of ideas and opinions. One can no longer simply disagree with the opinions of another—we have to hate those with whom we differ enough to want them to come to harm. The second thing that struck me is the false attribution. Why was it deemed necessary to create a fake identity called Werner Twertzog in the first place, and further, why did so many people then decide that this came from the German film director? We are bombarded with lies, half-truths and scams. It is almost impossible to trust anything we see or hear without engaging in extensive research to establish its validity. We now believe almost nothing or we swallow every bogus piece of information we come across as long as it fits our preconceived notions. One tends to reinforce the other. Somehow, we need to demand truth from those that purport to lead and inform us and somehow we need to reach a point where we can talk to one another again. I wish I knew the road to either one of these.

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