By Chris Kuehl, Ph.D., NACM Economist—
Short Items of Interest—US Economy—
Retail Numbers Boost Confidence
As the world started to open up for business, there was one burning question that hovered over everything. Would the consumer come back? This was especially important to the U.S. as the consumer accounts for between 70% and 80% of the economy. The first sign that consumers might be on the rebound came with the latest survey from the University of Michigan as it registered a slightly higher level of confidence than had been expected. The real signal came with the latest retail numbers as they were up by 18%. There had been an expectation of growth simply because retailers had been allowed to open, but few expected this bold recovery. If this pace continues for a while, the assertion of a recovery by the third quarter will be bolstered. It has certainly made the markets happy in the last few days.
Dramatic Shift in Consumption Patterns
Much attention has been focused on how people's lives have changed as they work from home, but there has been just as much or more change in terms of how people choose to entertain themselves. There has been a surge in everything from pools to home entertainment centers and recreational vehicles. There is a perception that event-based entertainment will be delayed a long time and may never be the same. That has people moving towards providing diversions at home. There is more money on hand for this investment as people have not been able to spend on the activities they indulged in prior to the lockdown. Even vacation plans have altered with more emphasis on traveling in an RV as opposed to going somewhere to stay in a hotel.
Reactions by States and Cities
The grim financial reality for state and local budgets will be forcing tough decisions very soon. There has been a near shutdown of traditional revenue sources as sales taxes disappeared. Property taxes also took a hit. At the same time, there has been an urgent demand for services to assist those that have been most affected by the viral outbreak and the lockdown. The budgets can't support all this. The most likely outcome will be a radical reduction in services where these have been deemed to be non-essential. There will be significant layoffs and furloughs as well as wage and salary reductions. Many of the most visible programs offered by local jurisdictions will be affected—everything from parks and pools to outreach and education efforts.
Short Items of Interest—Global Economy
Russian Tracking System Flawed
After denying there was any sort of COVID-19 issue, the Putin regime switched gears and started to demand that infected people be tracked and punished for violating the newly installed quarantine rules. The system has not worked very well. There have been thousands of complaints from people who are facing stiff fines for violating quarantine when they claim they have not. This has been the worry that many have expressed when the issue of tracking comes up. How accurate is the system and what are the penalties involved?
Battle in the Himalayas
The Chinese and Indian governments have claimed disputed territory in this mountain region for years and there have been clashes in the past. There had not been a violent episode for over a decade until now. The battle erupted when Indian troops went to verify that Chinese troops had pulled back from a strategic position. At least 20 Indian soldiers were killed and dozens more injured. The Chinese likely sustained deaths and injuries as well, but they have not reported them.
China Sees Resurgence of COVID-19
The leaders in China have been trying to eradicate the virus from the capital city, but that effort seems to be failing as new cases are being reported daily. It has not been understood where these outbreaks have been originating.
Reviewing the Indices
If you have been reading this newsletter for a while, you know that once a month we do a review of a series of economic indicators for two industrial organizations—the Chemical Coaters Association International and the Industrial Heating Equipment Association. Both of these groups have members that have been profoundly impacted by the lockdown recession as they heavily engaged in sectors such as automotive, aerospace, appliances and a wide variety of durable goods. They are in the business of working with metal—treating it, coating it and otherwise converting it in the products we count on. This is the executive summary of that report and a few of the sections of special interest.
Analysis: If you are faint of heart, this might be a good time to stop reading the report. As one would expect, there is not a lot of good news coming from this collection of indices. The lockdown recession has been with us for over three months now and there are few that have not experienced the impact. Having said that, it is important to offer a point of clarification regarding the data presented here. By most accounts, this will be the bottom and future reports will start to show slow improvement. The lockdown has been eased to a considerable degree. There have been consistent assertions that economic growth will rebound by the third and fourth quarter. It is true that some of this may be wishful thinking, but there are some indications that such a forecast may be realistic.
The charts show a very common theme—they all show declines that are nearly a straight line down. There is one notable exception to this rule. The data for the Credit Managers' Index (CMI) shows that same drastic decline, but with a nice little upwards trend at the end. Given that this is only bright spot in the report this month, some detail is in order. The CMI is an index that is structured similarly to the Purchasing Managers' Index with the same diffusion index which indicates that any reading over 50 indicates growth and any number under 50 suggests contraction. The index is divided into favorable and unfavorable categories from the perspective of a credit manager. The favorables include categories such as sales, applications for credit, dollar collections and amount of credit extended. The unfavorables include rejections of credit applications, accounts out for collection, disputes, slow pays and bankruptcies.
The severe decline that was noted in March and April was due almost entirely to the collapse in the favorable data. The sales numbers had been in the 60s and then they fell to the 20s and low 30s. So did the numbers for applications, dollar collections and amount of credit extended. This month, these numbers recovered substantially. They did not get back to the 60s or even the 50s, but they made it back to the 40s; that counts as promising. Credit managers tend to think in the future as they are most concerned with what shape a debtor will be in when they are due to pay. If a company has 90, 120 or 180 days to pay, the credit manager is not going to worry about them until that time. The fact that they are getting a bit more confident now indicates they are starting to see some positive developments down the road and not all that far away.
The other index items are all telling a pretty miserable story with record-setting declines. There is no mystery at all as to why this is the case as the lockdown was universal and sudden. There was no time at all for business or the consumer to prepare. There have been very few options available since the declaration. The expectation now is that the economy has likely reached the bottom and will show some improvement in the months to come. There was already some good news coming from the Labor Department as they released the latest job numbers. It has been expected that unemployment would hit 20%, but in the report, the number was somewhat less than feared—13.4%. Given that unemployment stood at 3.5% in February, it is good that over 3.5 million jobs were gained.
Where the economy goes from here will depend on three factors. The first and most important will be the attitude of the consumer. If there is to be a real rebound, the consumer will have to want to resume their old behaviors and soon. It is already evident that purchases of goods have improved, but 65% of consumer spending of discretionary income is devoted to services. These have been slower to recover (restaurants, bars, entertainment venues). The second factor will be the reaction of the government, which has varied from state to state. Some have been eager to reopen and others have put off this resumption until well into 2021. This set of decisions is dependent on the third factor. That is the course of the viral infection. Even though we know that 97% of those that contract COVID-19 get a version that does not require hospitalization, that still leaves close to nine million people at risk of a serious infection. Another outbreak in the latter part of the year, or into 2021, will create a demand for another attempt at containment and quarantine unless there is a better system for testing, tracking and treatment.
New Automobile/Light Truck Sales
The automotive sector has been one of the hardest-hit over the course of the lockdown recession, and for a variety of reasons. Not that other sectors have escaped the damage, but this category has been especially vulnerable. To begin with, there was the fact that union concerns over the health of the workers mandated an early order to shut down operations. Many of the companies that supplied parts to the assembly operations were likewise closed, while imported parts from Asia and elsewhere were significantly delayed. In many cases, these suppliers also closed or were cut off. Right now, there are over 500,000 merchant sailors stranded on their ships and in ports as they are unable to leave due to pandemic restrictions. This has all but shut down the global supply chain. As if all this were not enough, there has been a collapse in consumer demand as the lockdown has meant a drastic increase in job loss. Even those who have managed to hang on to their jobs are nervous as they do not know how long this will be the case. If there is any encouraging sign for the future, it would be that consumers will likely be relying on their vehicles for travel and entertainment to a greater degree in the future, but that is not doing the industry much good at the moment.
New Home Starts
The housing market is essentially in free fall at the moment and that is not likely to reverse in the immediate future. Even those who assert that a recovery might develop by the third or fourth quarter of this year are convinced that the housing market will lag that recovery, and perhaps for months. There are multiple issues here. The most important of these is the attitude of the potential homebuyer. The desire to seek a new home has diminished considerably due to the lockdown restrictions. There are millions of people who are no longer in a financial position to consider buying. The construction sector itself has been affected by a continued shortage of qualified workers. The bankers are still interested in providing mortgages, but there has been a significant drop in applications from both the upper and lower ends of the market. Those at the upper end have been hammered by the market collapse. That constrains their action. The only promising development is it appears that the millennial buyer is more interested in single-family homes than in the past. The people locked down in their apartments are now eager to get more space. When they start to look again, they might still move towards rejecting that multi-family option.
The level of steel consumption has also fallen off a cliff as the major markets for steel output have universally collapsed. The big three markets for steel include transportation manufacturing, construction and the oil and gas sector; all three are in serious trouble. The demand from the automotive sector fell as early as March and the first shutdowns, the construction sector has been a little slower to respond as commercial activity has managed to continue to some degree. The problem is that steel consumption in the construction sector is focused on the public sector. These projects have all but ceased. The fear is that infrastructure spending will not pick back up again for years as the government has gone into even more serious debt trying to blunt the impact of the lockdown. That leaves oil and gas. It has been weak as well—demand for oil is still a fraction of what it was. With prices as low as they have been for the last several months, there is little enthusiasm for stepping up production in the U.S. These operations need prices in the $50 to $60 range. They have been languishing in the 30s of late.
Industrial Capacity Utilization
The levels of capacity utilization have not been this low in many years—not since the recession of 2008-2009. The numbers had been flirting with normal only a few months ago, but the lockdown has essentially forced the entire industrial community to shut everything down. That has resulted in considerable idle capacity. The vast majority of the industrial community has been stymied by a combination of factors, which complicates the path to recovery. The shutdown orders are only the start. Now that elements of the economy are reopening, the other inhibitors are becoming more obvious. There have been significant supply chain interruptions that compromise the resumption of activity. There has also been very little improvement in consumer demand. The hope had been that consumers would be eager to resume their old patterns, but that remains to be seen. Early indications suggest that fear and trepidation continue to rule. The idle capacity will mean that expanded activity is not likely—little acquisition of new equipment and little in the way of new hiring. The little upwards blip at the end suggests there are some that are taking advantage of radically reduced prices for equipment.
PMI New Orders
The Purchasing Managers' Index has been chronicling the decline for months. Each edition looks a bit bleaker. There is nothing surprising about this development given the fact that almost every industry has been idled for months. There is no need to purchase anything in the way of inventory or new machinery when there is a lockdown in place. There is some encouraging news from the Credit Managers' Index, however. That will likely have an impact on the PMI data in months to come. The CMI often predicts PMI movement as the credit manager often does their job before the purchasing manager does theirs. The New Orders Index has fallen even further than the overall PMI as there is simply no sense of when there will be a return to any semblance of normal. The current reading is one of the lowest in the history of the index—worse than what was registered in the 2008 collapse. The primary culprit has been the uncertainty as to when there will be a real end to the lockdown.
There is always a good deal of volatility when it comes to capital expenditure as there are always a variety of factors that contribute to the decision on what to spend and where to spend it. In good times, there is spending in anticipation of future growth—a desire to stay ahead of demand with new machinery and expansion. In bad times, there are opportunities to buy on the cheap as prices tend to fall for machinery as well as for property. There are also opportunities to make acquisitions as there are many companies that find themselves in trouble and are available on the cheap. There was some of that bargain hunting last month, but that seems to have faded this month. Capital expenditure is heading down again. It will not rise much until there is some general sense that a recovery is actually underway.
Speaking to Actual Live People
Yesterday was something of a banner day as it was the first time since mid-March that I had the opportunity to speak to a group of real live people instead of through some virtual platform. Mind you, I also had two webinars yesterday, but the Chamber of Commerce meeting provided me an opportunity to actually see people and to interact with them. I realized just how desperately I have missed this. It was not only the opportunity to see faces and read expressions, it was the opportunity to hear what people are thinking. I had time to converse with several people to get a sense of what is going on with their businesses.
There was the head of the group talking about how his company was adjusting to the work at home shift. Productivity is up because people end up working far longer than they would otherwise, but that is starting to create serious burn out. There was the restaurant owner worried about the loss of ambience and intimacy that attracted people to his place. There was the woman worried about hanging on to her long-time employees as she has many women with children working for her. They will have to figure out child care when they return. Many are worried they will not be able to afford it. The questions I got revealed that people know their world has changed, and likely forever. They sincerely want to do the right thing, but face difficult choices that will affect a great many lives. I knew this was the case from simply following the issue for the last three months, but it is very different to hear the stories directly and personally.
Transportation Activity Index
The transportation sector is often referred to as the harbinger of things to come. The whole economy relies on the transport of goods from one place to another—raw materials and commodities in and intermediate and finished goods out. The supply chain is the key to most business activity. There is significant difference between the various modes of transport as well. The air cargo sector is usually the most sensitive as it only comes into play when there is an urgent need and there is a willingness to pay for the speed. At the very heart of the transport sector is ocean cargo, as close to 80% of all goods that are produced in the world will be shipped by sea at some point. The chaos in ocean cargo at the moment is unprecedented. There are close to 500,000 sailors stuck on their ships or in ports where they can't depart or dock. They have been quarantined or the origin has been or the destination is off limits. Thousands of ships are sitting idle. That is putting a significant kink in the global supply chain. The follow-on impact has affected the rail and trucking sectors as well.