Strategic Global Intelligence Brief for July 30, 2018
Short Items of Interest—U.S. Economy
Interesting Comment from Ford and GM
Both companies reported that higher steel and aluminum prices stripped about $300 million off their quarterly results in Q2. They blamed it on higher tariffs. That's a big part of it, but a strong demand environment could also be just as much at work to push prices higher. One other interesting data point that came out of their reports: they both reported that today steel accounts for about 53% of the material in a typical auto and aluminum accounts for about 11%. Many additional Q2 earnings reports will be released next week, several of which involve companies that are impacted by higher raw material prices. We'll see what the commentary is like as we get those additional reports—but believe that it will remain consistent.
Chicago Fed Index Has Strong Rebound in June
The Chicago Fed's reading on business activity shot up from -.15 to +.43 in a single month. It's volatile, but the positive aspects of the report were buoyed by better industrial production, manufacturing production, employment, sales, new orders and larger inventory building activity leading the pack. The only negatives were some slight drops in housing starts and permits (much of that being labor shortage-related in any event). The industrial production surge was an important sign. Anyone operating supply chain activities in the region needs to pay attention to it. Surges in industrial production almost always lead to tighter transportation activity. And, in this environment, that will exacerbate the supply chain bottlenecks throughout the upper Midwest. For the rest of us, translate that news into higher operating costs, strong revenue opportunities for companies in the region, but a tighter profit picture if they aren't managing costs correctly.
Durable Goods Report Was Strong in June
I know we just had the Q2 GDP release, but some of the data in the release will still get revised over the next couple of months. The June Durable Goods report gives us a couple of critical insights into real-time activity. And it was generally good. New orders for durable goods were up 1%, or $2.5 billion. When we strip out transportation, it was up .4%. Inventories were weaker, down by .4%. That's not too surprising given some of the reports that we've been getting from manufacturers. Most are reporting that they can't get enough raw materials and labor, and suppliers are delayed in getting critical components and inputs to them. Throw supply chain bottlenecks and difficulty getting transportation capacity, and it's a tough environment for them. So, the lower inventory figure is probably a factor of supply, rather than manufacturers wanting to purposefully drive inventories lower. The big figure to keep an eye on is the CapEx spending component. Corporate spending on big ticket items was up: 6% month-over-month and 6.8% year-over-year. That's still strong corporate investment and spending.
Short Items of Interest—Global Economy
Wow! Venezuela's Hyperinflation to Surge 1,000,000%
That's not a misprint. The International Monetary Fund (IMF) is predicting that Venezuela's bolivar will see enough deflation that it will push the countries inflation up by more than 1,000,000%. That's an economic disaster—and it continues without any real plan in the works to help improve the situation. At some point in time, the IMF will have to push global entities like the UN to consider some sort of intervention—or continue to watch a human disaster unfold in front of it.
A Truce is Not an Agreement
The meeting between President Trump and the EU's Jean-Claude Juncker did not go as expected—there has been intense debate over what actually did take place. When the two were scheduled to meet, the prevailing wisdom held that they would essentially talk past one another and bring up the same issues and inhibitions that have been in place since Trump took office. There was nothing in the statements prior to the meeting that would have led anyone to expect anything significant. President Trump seemed to take Juncker by surprise with a suddenly conciliatory tone. The threats of a trade war that had been made only a week ago were dropped amid talk of a "truce." The problem is and was that there are no details as to what this means. In the short term, it looks like the threat to impose tariffs on cars made in Europe and shipped to the U.S. would be delayed and perhaps abandoned altogether. There were further hints that restrictions on steel and aluminum would vanish and the Europeans could sell to the U.S. again, but there has yet to be a timetable set. What else might have been discussed or agreed upon is murky.
Analysis: One division has emerged already. President Trump wasted no time in addressing a group of farmers assuring them that he had wrangled a new deal from the EU that would throw open the market to the U.S. farm community. This comment came as he has been trying to assure them it would be protected to some degree from potential Chinese reaction to imposed tariffs by the U.S. Farmers stand to lose a great deal of market share in this fight and many are deeply concerned about their ability to survive this potential trade war. The response from Trump has been to create a $12 billion fund to bail some of them out. This has been unpopular with the farmers as they do not have an interest in welfare for a year as compared to being allowed to keep developing a market they have been working to penetrate for years. President Trump is trying to soften the blow by asserting that he has opened up the European market. The response from Europe has been swift and declarative. There was no deal done and there was not even a discussion of the issues that have been solved.
The point is that European agriculture is highly protected and always has been. There is a concerted effort to preserve the rural areas. That has meant considerable attention paid to the farmers. They receive substantial subsidies from the EU and their own national governments. They are further protected from imports from all over the world. Beyond the preservation of the rural communities, there are issues of safety and health. GMO foods are often banned and so are types of hormone-treated meat. Certain farming practices are banned as well. These are just some of the barriers that exist to U.S. farm exports. It is quite true that U.S. farmers would welcome an additional avenue to trading with Europe, but this has been on the U.S. agenda for decades and most of the conversation has been fruitless as the Europeans protect their farmers as much as any other nation.
It is obvious why President Trump would want to be able to make this claim as the U.S. farm community is very worried about the impact of these tariff wars, but it is hard to understand why a claim like this would be made as it will be very obvious to those farmers in the U.S. that they will get no more interest than before. It may be an attempt to bully the Europeans into these concessions, but this is the least likely place for the EU to give way.
Budding Friendship Between Trump and Italian Leader?
The victory of the outsiders in Italy brought a coalition of the Northern Alliance and the Five Star Movement. The former is a right-wing group that is strong in the northern parts of the country and the latter is a populist group that is stronger in the cities. It took months for the two to settle on a compromise candidate to lead the group—Giuseppe Conte. He is a former law professor who had never held elected office. He has struggled to make much headway with the other European leaders as they are quite distrustful of the current coalition. The Northern Alliance position on immigration has been a major sticking point.
Analysis: Conte has reached out to the U.S. The gesture was warmly received as Conte and the Italian ruling coalition have all the traits that President Trump values. They are outsiders and populists—fond of broad generalizations that inflame the base of both the Alliance and Five Star. The Italians are shunned to some degree for putting a rookie in control, but he is seen as a chance to change whatever various people think to needs to change.
Where Did the Growth Come From and How Long Does This Last?
As this is an election year, there is an uncommon level of interest in economic data and predictions. This all makes perfect sense as we are all familiar with the phrase "it's the economy stupid"—uttered by Bill Clinton's campaign manager (James Carville) in his campaign against George Bush, Sr. Not that anybody had to really point out what most motivates the majority of the voting public. The voter in the U.S. is reliably split into three groups; all three have their role to play in an election year like this one. The first group is active now and has arguably the most influence despite being the smallest in number. These are the primary participants. They are the most motivated as well as being the group that places economic issues as a generally lower priority. They will try to ensure their social issues dominate and that the standard bearer for their party will reflect their beliefs. Generally speaking, this group is made up of people who take more extreme positions on the left and right. The next group of voters is those who do not engage until the general election. These are the people who react to larger national issues such as the economy or national security or some social issue that captures the attention of the majority of people. Soon enough, these voters will be the target and every twist and turn of the economy will be focused upon. The largest group of voters are those who are eligible to do so but don't. They are unlikely to engage at all, but if they do, the motivation is very often the economy and how it is affecting them personally. Traditionally, a strong economy is connected to lower voter turnout and favors the incumbent parry as people have less desire to rock the boat and change anything.
Analysis: Given this, what role does the GDP number play in the election this year? There will be one more release of this data before the campaigns are over as third quarter numbers will come out in October—right before votes are cast. There will also be a couple of revisions to the Q2 numbers, but they never get quite the attention the original data gets. The Q2 data is the most persuasive as far as those that pay attention to the economy because most voters will have made up their minds about their candidates by October and the Q3 release. If there is some dramatic change by that quarter, it could have an impact, but we would have to be talking a major collapse. This is why the second quarter numbers are so pivotal right now. Everybody wants to put forth an interpretation that best fits their narrative. Inevitably both sides make more of the data than is really justified.
The president and the GOP are pushing the narrative that all of this growth is due to their policies and efforts. The 4.1% growth is because of tax cuts and trade policies favoring the U.S. There is reference to the growth in the business community due to relaxed regulation and the perception of a more pro-business environment in government. Other factors that may have played a role in this growth are given short shrift. For example, one of the more important factors in this quarter's growth has been exports. Not that this has not always been a big part of the U.S. GDP, but the situation this quarter was unusual. Buyers were extremely active as they were trying to buy as much as they could of goods and commodities that might be part of a trade war. This level of sales activity will not be repeated this year. In fact, the rate of sales will decline precipitously if these tariffs are put into effect.
The Democrats are taking a far different approach to the economic data as they are pointing out the flaws in the prevailing logic as regards growth. GDP numbers are at best a blunt instrument and say very little about how this wealth is distributed or who benefits or even what the ultimate cost of that growth might be. Even in the best of years, there is widespread variability as far as GDP impact with some states growing very quickly while others are lagging. A good GDP number doesn't address anything other than the amount of goods and services produced in a given period—it doesn't say anything about poverty levels or whether these are the "right" things to produce. This is a far tougher and more complex argument to make, however, as most people will simply assert that growth is good and leave it at that.
The factors that played a major role in this quarter's data will likely fade a little by the end of the third quarter. The four that have been credited with the Q2 growth include the export levels mentioned earlier, strong consumer spending, increased business investment and additional government spending. The consumer will be a factor through the rest of the year and how much will be indicated by what happens with the start of the back to school sales and pre-holiday activity. Business investment was closely tied to the tax break. This is now quite a few months in the past. Government spending has been the wild card—far more than had been predicted.
A Couple of Warning Signs
There is no silver lining without the accompanying dark cloud and there are factors that come into play with this kind of new data. The most important is that it provides more justification for the Federal Reserve to keep hiking rates. It is obvious that the rate hikes thus far have not dampened enthusiasm, so there is no reason to expect a reversal now. The other caveat that comes from the data is that consumer sentiment sagged a little from its 14-year high. There was also evidence that consumers are saving less and accessing the credit cards more heavily.
Analysis: Consumer attitude is notoriously fickle and few pay attention to month-to-month changes. The long-term trend has been very clear and seems strong—even now. The bigger issue is the advance of inflation. All the signs are pointing that way. Thus far, it looks to be a manageable version of the malady and the Fed has been proactive. The consensus view is that inflation provokes the Fed to usher in a short recession in 2019 or 2020.
Symbols
I have never been that enamored of symbols. Not that I don't appreciate their value, but I am not as committed as some. There are those that wear the banner of their favorite sports team as a statement of who and what they stand for. I have seen actual riots break out over who is wearing what in a given situation. Then, there are the symbols of national identity and those of historical significance. This has been a year of intense debate and even conflict over such symbols as the American flag and statues commemorating wars long past. All year long, there have been fights over the flag and other national symbols. There have been large numbers of statues torn from their previous perches as it has been deemed inappropriate to honor those who led the rebellion against the U.S. in the Civil War.
Are these symbols worth these levels of animosity? I do not understand that level of substitution. I salute the flag and stand for the anthem and fly it on appropriate holidays, but it remains a symbol for me. The "for which it stands" is far more important to me. I would rather defend our rights of speech, press and assembly than the cloth itself. I understand the frustration of looking at statues of people who would enslave me and who killed people from their own nation, but doesn't tearing apart that symbolism reduce the opportunity to have a real conversation about what that person did or didn't do. I see these statues as an opportunity to ask about the issue and emotion behind that edifice.
