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Strategic Global Intelligence Brief for June 24, 2019

Short Items of Interest—U.S. Economy

Existing Home Sales Up in May
Given the slump in new home sales, there had been fears existing home sales would also be down. The sector has been an important driver and indicator for the greater economy and there have been signs of a slowdown. This month, the news was a little better with sales up by 2.5%. The existing home market is much larger than the new home sector and reacts more quickly to mortgage rates. As these have come down a little, there has been more demand. Prices have risen some, but not as much as new home costs. The existing market has not been affected by the labor shortage that has plagued the new home builders.

Consumer Confidence
Keep an eye on the latest consumer confidence survey from the Conference Board—due to be released tomorrow. Granted, the gauge of consumer attitude is always tricky as the consumer can be very fickle, but the curiosity this month centers on their potential reaction to issues such as the trade wars. The media has been reporting a lot of business angst and the overall national data has been weaker of late. Has all this bad news started to filter down to the consumer? This latest survey will provide something of a clue.

More Data on Friday
The Commerce Department will release a load of data on Friday, June 28. That may have an impact on business and investor attitude. There will be information on personal income, consumer spending and inflation; the news should be fairly good. The expectation is income levels will be up by 0.3% and spending by 0.5%. At the same time, the inflation level will be stable. All that would combine to convince the Fed that interest rates need not move all that soon. So far, the distress in the global economy has not manifested in the U.S.

Short Items of Interest—Global Economy

Resignation Complicates India's Banking Crisis
The current head of India's central bank has resigned—only a few months after the resignation of the previous head. For the last year, there has been an intense confrontation between the Reserve Bank of India (RSB) and Prime Minister Narendra Modi. The RSB has challenged the economic policies put forward by Modi and Modi has tried to either blunt the RSB or pack it with supporters. This has undermined its independence and authority. That has affected the entire Indian banking system adversely.

Some Winners in This Trade War
It is unlikely that many U.S. manufacturers will be swooping in to start making the stuff that has been imported from China. The U.S. makers can't provide the price that consumers demand. Vietnam can and is rapidly moving to capture that open market share. The manufacturers in Vietnam are riding a boom they haven't seen in years—taking full advantage of the diaspora that exists in the U.S. This is not the only nation that seeks to expand trade relations with the U.S. Bangladesh, Sri Lanka, Argentina and many others have been aggressive in courting the manufacturers and importers that are worried about their Chinese supply chain.

Tory Leadership Battle Heats Up
Boris Johnson's lead has evaporated according to polls. As the Conservatives try to decide whether Johnson or Jeremy Hunt is the right person to lead, the strategy that Johnson has pursued seems to be fading. He has made this all about Brexit and his hardline stance, but the rank and file are also concerned about other issues and have started to note that Johnson's mercurial temperament may not play well with voters. Hunt has positioned himself as the "serious candidate" and the "only adult in the room." He has essentially asked the Tories if they really want their own version of Donald Trump as PM. Some definitely do, but more seem to be on the fence.

Manufacturing Slump Becomes a Concern
The strength of the manufacturing sector has been a solid driver for global growth for the last few years—even for an economy such as the U.S. which remains overwhelmingly connected to the service sector. There are many ways by which to assess the strength of the manufacturer—data from durable goods and factory orders, capacity utilization data, capital investment and other measures that are specific to a given industry such as home sales, auto sales and aerospace. The one measure that seems to attract the most attention by its longevity and accuracy has been the Purchasing Managers' Index (PMI). It gets is reliability from its simplicity and the honesty of those that respond. It is simply a report on what purchasing managers are buying or not buying in a given month. The activity of the industrial sector will determine how much is purchased in the way of raw materials, commodities, parts and all the other inputs that are required by a given operation. Add all this activity up and one has a tidy little snapshot of the world of the manufacturer. It is also a powerful tool because it is easy to understand—anything over 50 is expansion and anything under 50 is contraction. The fact that the PMI is done exactly the same way for over 30 nations makes it a system that can be compared easily regardless of national differences. The PMI in the U.S. means the same in Germany, China or Brazil. This month's collection of PMI data is as weak as has been seen in close to 10 years. That has added to the general sense that trends are starting to reverse and fast.

Analysis: The latest PMI for the U.S. is at 50.1, down from the 50.5 reading notched in May. These are about as close to contraction as one can get without falling into it. The numbers for the New Orders Index have stumbled ever further and are under 50 now. This is not an isolated situation either as most of the other industrial nations are experiencing the same set of problems. The PMI for the eurozone is as low as it has been in six years and the data for Japan is as low as it has been in three. China is down to levels not seen since the 2009 recession and their PMI for small companies is even lower than the one for the large corporations. In fact, the global PMI data is universally low and has been dragging down even those economies that were growing just a few months ago.

The reasons for the slowdown seem to be universal—at least that is the impression one gets from listening to the statements from the various central banks and the analysts who have been examining these readings. At the top of the list is the trade wars and all the tensions that have erupted over the unpredictable nature of U.S. tariff policy. There has been no consistency at all. That has forced companies to try to adapt to every contingency. Some have added inventory in anticipation of shortages only to get stuck with too much. Others have not added any and got caught without needed materials and parts or have had to pay much higher prices. The U.S. trade partners have no idea what status they have and that creates stagnant confusion.

The second issue is related to the first as there is a concern regarding the rate of global growth. It has slowed dramatically and quickly. That comes as little surprise given the slow growth that has marked most of the industrial world. Europe is growing at less than 1% as they face everything from Brexit turmoil to trade issues. Japan has slowed to less than 1% due in no small part to the fact China has slipped to around 6%. This level of growth in China is tantamount to recession and keeps China from buying the output of other nations—many of them in the emerging market category.

The third issue is a very long-term concern and one that has been getting steadily worse for years. It is also an issue that will be nearly impossible to address in the short term. The shortage of qualified workers in manufacturing is acute and is affecting nearly every nation—even those with very large populations such as China and India. The manufacturing worker of yesteryear was not all that skilled. The average factory employed a lot of these semi-skilled workers. Today, the level of expertise required is far greater than in the past and countries have been unable to keep pace. The lack of workers has affected productivity and has slowed the ability to expand to meet demand. The other issue is that people who once had jobs that paid decent wages in manufacturing have lost these positions and have had to replace them with service sector positions that do not pay nearly as well.

The fourth issue is the reaction to the stimulus of last January. This tax break was welcome but with reservations. It was considered to be too late to make a big difference. To have maximum impact, a tax break or additional government spending needs to come when the economy is truly struggling and people as well as business need immediate help. The stimulus would then encourage additional growth and additional hiring. The economy in the first quarter of 2018 was not struggling. There had been two quarters of 3% growth in 2017 already and the jobless rate was 4.1% on its way to 3.9%. Business would have had a hard time hiring additional people even if there had been a desire to. The stimulus was not much more than a "sugar rush" and the impact was very short lived.

What Next in Iran-U.S. Conflict?
The tension has been ramping up for weeks as the engaged nations in the region set about testing the limits of their adversaries. The battles within these nations have become as fierce as those between the involved countries. Hardline elements in Iran include some of the aging Ayatollahs on the Council of Guardians as well as members of the Revolutionary Guard. It is very likely that it was from this hardline group that the order came to shoot down the U.S. drone. Many suspect it is also behind the attacks on the oil tankers trying to pass through this region. There are, however, moderates within the legislature that are still led by President Hassan Rouhani. He has been flummoxed by the failure of the nuclear deal as that was the means by which he would be able to mollify the hardliners. Now the momentum has swung entirely to those that want to challenge the U.S.

Analysis: That same battle between the hardliners and pragmatists exists in the U.S. with National Security Advisor John Bolton and Secretary of State Mike Pompeo taking an aggressive posture that includes military assaults on Iran. They have been opposed by the military in the U.S. as they fully expect that such an attack would lead to counter attacks and the risk of an outright war. Trump was on the side of Bolton and Pompeo, but shifted at the last minute and called off the attack. Instead there will be ever-tighter sanctions, but the reality is there is very little left for the U.S. to sanction. Putting additional pressure on the Iranians will mean getting cooperation from other nations, but there is either reluctance or outright hostility to the U.S. strategy.

The European position was to support the moderates in Iran by backing the nuclear deal. That was thought to have removed the biggest threat posed by Iran and would leave time to address the other concerns such as support for terrorist groups and insurgents such as Hezbollah and Hamas. They have been reluctant to support the U.S. sanctions, but have been persuaded to some degree by the threats issued by the U.S. Russia and China could not possibly care less what the U.S. wants in the Middle East and both are actively supporting the Iranians by buying their oil and providing access to their financial markets. Russia has even hinted that an attack on Iran would be met with a response from the Russian military. There has been movement of Russian naval vessels to the region. It is also possible that Russian troops will be sent to Iran to essentially complicate U.S. and Israeli attempts at air strikes as there would be a chance that Russians would be among the casualties.

Thus far, the oil markets have remained surprisingly calm. The sense is this is all just posturing and that nobody really wants open conflict—least of all a president preparing to run for a second term. To the degree there is concern, it is over the belligerent posture adopted by Pompeo and Bolton as well as Israeli Prime Minister Benjamin Netanyahu. This is the real wild card. If Israel decides to launch a preemptive strike on Iran and is subsequently retaliated against, that might be enough to get the U.S. to engage.

Erdogan's Gamble Fails Miserably
The regime of Recep Tayyip Erdogan suddenly looks very vulnerable. A few weeks ago, his ruling AKP lost mayoral elections in both the capital city and the country's largest city. Losing Ankara and Istanbul was a major blow and Erdogan used every trick in the book to blunt the opposition. The courts (which Erdogan had packed) held that the original election was void as there had been "irregularities"—an assertion that international poll watchers denied. A second vote was called. In this one, the AKP was utterly crushed in a landslide that can't be challenged. Erdogan is now as weak as he has ever been.

Analysis: In the first election, Ekrem Imamoglu won with just a 14,000-vote lead. Now his lead is 800,000 and he sets himself up to be the most important challenger Erdogan has ever had. The political reality in Turkey is that whoever controls Istanbul controls the future of Turkish politics. The issues that have carried Imamoglu have been economic, a potent campaign topic in the past. The Erdogan regime always had the strength of the economy as a support, but for the last two years the country has been sliding deeper into recession and the population has lost faith in Erdogan's ability to turn things around.

The AKP has been left with issues such as the Kurdish threat, commitment to Islamic principles and hostility towards the U.S. and Israel. These are still important to a segment of the population, but even among those that list these as vital, the state of the economy ranks nearly as high. The sense is that Erdogan has alienated too many allies and has allowed corruption around him to undermine the country's ability to grow. Inflation has also become a bigger threat.

Reducing Regulation Through Inertia
One of the issues Trump campaigned on was de-regulation. If there was a consistent complaint by business during the Obama years it was over the greatly expanded regulatory reach of the government. In the wake of the recession debacle, there was a great deal of emphasis on "making sure THIS never happens again." That meant new laws and regulations. It has been harder to remove these strictures than originally assumed, and this has triggered a different approach.

Analysis: The majority of the regulatory agencies are being starved of funds and the size of their staff has been drastically reduced. Agencies such as the Consumer Financial Protection Bureau has seen enforcement efforts reduced by 80%. The EPA has seen a 60% reduction in the number of actions taken.

Amateur Hour
It is a guilty pleasure. I know this, but I am still hooked on shows like "America's Got Talent." I look at other national versions of this show on YouTube as well (the Japanese have some truly wild "talents"). Even as a kid I remember "Ted Mack's Amateur Hour." I realize that many of those competing on AGT are hardly amateurs, but they are at least somewhat undiscovered. I just enjoy seeing people dedicated to something that may never bring them all that fame and fortune others crave. They do this out of an inner drive that seems impervious to the opinions and judgments of others. I get people who fancy themselves singers or dancers or magicians seeking that big break, but what motivates a woman to train rats to accompany her acrobatics? What propels a bunch of high school kids to devote those long hours to a skill that they will not use again once they graduate?

These are the people that do this out of the most personal of reasons—it brings them joy and satisfaction and it is a bonus if it brings others some of that joy as well. My wife sings in a chorus (as alert readers already know). It is a non-audition chorus. That means anybody who wants to sing can be in the group. This could be a recipe for pure discord but these 80+ people take this very seriously and perform spectacularly—even commissioning pieces from some of the most well-known composers of the day. They are trooping off to rehearsal week after week for the pure joy of singing. Luckily for the rest of us, they allow an opportunity to share that joy a few times a year. It is the fortunate person who has that joy in their life, while the rest of us are fortunate they are willing to share it.

Crude Oil Price Forecast
Forecasts that go out this far (2025) are notoriously unreliable as there is no way to predict all the variables that go into pricing oil. The World Bank estimate looks just at proposed demand and supply factors and holds the unpredictable events as givens. In other words, if one assumes that all the political and weather-related inputs hold steady, this is the price trend. What makes this interesting is that prices are still relatively low some five to six years from now—just barely past $100 a barrel. It is useful to note that the expectation is that global growth will be between 4% and 5% for these prices to hold. Right now, the growth rate is only 3%.

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Saturday, 07 December 2019