Strategic Global Intelligence Brief for May 14, 2018

Short Items of Interest—U.S. Economy
Gas Prices Headed Up It was only a few months ago oil analysts were confidently asserting the price of gas would not hit $3 anytime soon. It just didn't seem that any of the root factors would be much of an issue. The overall supply of oil in the world was more than sufficient for the expected level of demand. That has all changed in very short order. Most of the change has been on the supply side. First it was OPEC and Russia agreeing to limit their output followed by sudden reductions from other African and Middle Eastern states. The final straw was the decision by the Trump White House to withdraw from the Iran nuclear deal and impose new sanctions. The upshot is $3 a gallon gas and above this summer. That will cascade through the economy with higher trucking costs, higher airfares and less activity as far as driving trips.
The Return of the Quota In order to escape the impact of the threatened tariffs on steel and aluminum, there are several nations that are now accepting quotas on what they can ship to the U.S. as a way to avoid the tax. This essentially shifts the burden of reducing imports to the U.S. companies that need these imports. In the past, the quota has been seen as the worst solution imaginable to the issue of deficits in trade. It means that manufacturers using that steel or aluminum will suddenly not have access to this material at any price as the quota will have been reached. The country selling that product will price accordingly and will essentially cause a bidding war.
Auto Sector Jobs The Trump approach to jobs in the auto sector is simple enough. It is based on taxes, tariffs and restrictions on who can sell cars in the U.S. The plans that are being kicked around include restricting the import of foreign cars and imposing new taxes on U.S. makers if they do not create jobs in the Rust Belt states. There is a wholesale rejection of the direction that car making has been headed—towards more robotics and automation. The Trump plan seems to be replicating the way that cars were made in the 1970s and 1980s—perhaps a revival of the Pinto or even the Gremlin is in the cards.
Short Items of Interest—Global Economy
Policy Reversal on ZTE Just a few weeks ago, the Chinese telecom company ZTE was under attack and was being banned from a whole host of U.S. business opportunities. All of a sudden, Trump has expressed deep concern for the loss of Chinese jobs and has pledged to get ZTE back in business. They had been hit by sanctions related to their engagement in Iran. Most see this as a ploy to get some cooperation from China on other issues—essentially trade related. What has been odd about this plan is the expressed concern about the loss of Chinese jobs—something Trump had not been concerned with before.
Anti-U.S. Cleric Takes the Lead in Iraq's Polls It looks less and less likely that current Iraqi Prime Minister Haider al-Abadi will be able to get a second term. Now, the U.S. is facing the prospect of a virulently anti-American cleric taking that spot. Muqtada al-Sadr once led his militia troops against the U.S. and is very close to his fellow Shiites in Iran. His lead is not insurmountable and his popularity is limited to the third of the nation that is Shia, but the other candidates are just as fragmented in their support with Kurds supporting Kurds and Sunni supporting Sunni.
Investment Spending Still Lags in Europe It has been a decade since the economic crisis in Europe and there has yet to be much recovery in terms of either business or government investment. The levels are still lower than they were at the start of the downturn in 2008. The caution in the business community stems from the sense that consumers are still not engaged, while the government remains strapped for the cash that would normally have been plowed into infrastructure. The sense remains that Europe is still far more interested in frugality—at all levels.
A Look at the Current Indices Faithful readers of the newsletter will know that we prepare an index of indices for a couple of manufacturing groups—the Chemical Coaters Association International and the Industrial Heating Equipment Association. These are readings that give them some insights into the economy and what is happening at the moment, as well as what they might expect in the mid to long term. What follows is the executive summary in addition to a few of the more detailed breakdowns.
This has been a tumultuous year as far as the economy has been concerned and there is little indication that this pattern will reverse any time soon. In fact, as this is an election year, the chaos will only intensify as the summer campaign months begin. There has been both the expected and the unexpected. The tax cuts at the start of the year were supposed to be the seminal events of 2018. Thus far, that has been about half correct. The business community has responded well. That shows up in most of the industrial data below, but the consumer has been sitting this one out—at least so far. There is an expectation of more consumer activity during the travel and vacation months, but if that doesn't pan out, it will be assumed that consumers are still worried about leverage and may have started to fear inflation. Of the 12 readings, eight of them are trending positive and only four are in negative territory.
Analysis: The new automobile/light truck sales reading remains solid despite some factors that might have discouraged people from buying that new vehicle. The good jobs numbers are playing a major role—giving people confidence to go out and spend on bigger ticket items. The costs of steel have gone up, but the sector appears to be eating that additional expense as opposed to passing it along to consumers. There was a slight dip this month, but for the most part, the data has been consistent. The second negative trend is also a bit of a surprise as it is the price of metals like aluminum, copper and gold. They should be trending up with all the turmoil over tariffs and the threat of inflation, but the sector appears to be taking a breather. The third negative is the new orders index from the Purchasing Managers' Index (PMI). It is important to recognize that the numbers are lower than they were last month, but are still in the 60s and considered very strong. The overall PMI also slipped but has stayed in the mid-50s, solidly in expansion territory. The last of the negatives is the Credit Managers' Index, the only one causing some heartburn. The good news is that most of the favorable readings are in the 60s, but the bad news is that dollar collections are way down. This may be an anomaly, or it may suggest that companies are starting to get very protective of their cash positions and have chosen to try to stretch their creditors out for a while.
The eight readings that trended positive are all signaling a healthy economy, and in a variety of sectors. The data on new home starts has been erratic all year and likely will continue to be. The multi-family unit is still driving the new home sector, while the single-family home is trending towards the higher-dollar builds. Steel consumption is way up, but not really due to demand. There is deep fear that steel will be in short supply and far more expensive in the future. That has many users trying to stockpile as much as they can as long as those tariff threats hang over the users. The capacity utilization numbers are very close to the bottom end of ideal at 78%. Many sectors are already seeing utilization numbers at 80%. Some are even seeing readings over the 85% level signaling problems with supply. This number often twins with the capital investment data as has been the case this month. The capital expenditure (cap-ex) numbers are recovering from their first-of-the-year dip.
The tracking of durable goods and factory orders as well as appliance activity is pointing to solid growth. The durable goods numbers have not even been inflated by the aerospace sector this month as is sometimes the case. The U.S. is not a big producer of consumer goods, so these factory orders are generally aimed at the same industrial community tracked by durable goods data. The last of the positive trends is seen in the transportation index which has flattened out a little but at a high level. The majority of the growth has been seen in the rail sector despite the fact that coal shipments are down and grain activity has yet to get underway. This seems to be concentrated in the intermodal part of the business. The growth in trucking has also been respectable. That leaves air cargo as the weak spot as expedited shipping is not yet a high priority.
New Automobile/Light Truck Sales The level of vehicle sales has continued to hold pretty steady with only a small dip this month. This is both surprising and not so surprising as there have been factors that could have pointed sales numbers either way. On the positive side, there is continued strength as far as the consumer is concerned. The latest confidence surveys from both the Conference Board and the University of Michigan are showing good numbers. The employment numbers have been equally positive with a low rate of 3.9% reported. There has always been a strong correlation between jobless numbers and the confidence in the consumer sector to engage in big purchases. On the other hand, there has been data that pointed to lower sales. The rise in wages that would be expected with unemployment levels this low has not come to fruition. That would seem to leave people more cautious as they start to anticipate higher levels of inflation. There has been some tightening of credit lately (again in response to potential inflation), but this seems to have hit the mortgage market harder than the car market.
Industrial Capacity Utilization This is a market that gets a lot of scrutiny from those who are trying to assess the future of the economy. As has been reviewed before—the ideal place for capacity utilization is between 80% and 85%. Less than 80% means there is still too much slack and business will not be all that interested in either buying new machinery or hiring people. Once capacity usage goes over that 85% mark, issues of shortages and bottlenecks start to manifest. This is a time when machinery orders go up and more hiring takes place, but that assumes there are people who are worth hiring. The numbers now are as good as they have been in some time and are getting very close to the levels that would suggest an ideal situation. It is also good to remember that this is an average. Many industry sectors are already in that sweet zone and some have already shot past that 85% level. This has been seen in some of the medical sectors and parts of the construction sector in the hotter markets.
New Home Starts The housing market has been all over the map the last few months. A good month is followed by a decline. Then there is another rebound. It appears to be a battle of wills. On the one hand, there are all the headwinds that had been identified throughout the year. The mortgage rates have been rising steadily in many markets and the price of homes has skyrocketed in most of the hot markets. These two developments have all but priced the first-time buyer right out of the market. There are further issues that have affected the markets that have been the most robust—everything from labor shortages to inadequate inventory. The main focus for the builder has been the higher-priced homes; the starter market has been in decline in most parts of the country.
As has been the case over the last decade, the real growth in new housing has been in the multi-family category. That remains the case in most markets. The new home sector is much smaller than the existing home market, which continues to be the case. The assertion is the overall market will remain strong enough for the next few months, but will likely sag a little later in the year.
Steel Consumption The steel sector continues to be roiled by all the drama over steel tariffs and threatened trade wars. At last check, the majority of the countries that import steel into the U.S. still have an exemption, but these have been granted for no more than a month or two at a time and remain contingent on how cooperative they are deemed to be by the Trump White House. This essentially means that tariffs are being imposed on less than 15% of imported steel (generally from China, Russia and Japan). In addition to the exemptions that countries have been granted, there are exemptions offered to U.S. purchasers of steel if that type of steel is not available from U.S. producers. The whole issue has been highly politicized.
Even though most imports have not been affected, there has been a substantial price hike as the steel producers are anticipating an impact from the tariffs. It is akin to the transportation companies imposing a fuel surcharge even though they are not yet paying for that more expensive fuel. Consumption levels are up as many users are attempting to beat any further price hikes by buying what they might need months in advance. There is also more demand noted from the construction sector as there has been more of that public sector infrastructure work.
Metal Pricing Some of the metal pricing has been somewhat counterintuitive. The price of gold would normally be rising as the threat of inflation loomed. This is the traditional hedge for those seeking protection, but the demand has been less than was anticipated. The aluminum prices have tumbled from their peak, but have just started to ramp back up a bit as the threats of tariffs and bans accelerate. The issue with the aluminum tariffs is less about the U.S. imposition of a 10% additional tax and more to do with the sanctions that have been imposed on Russia. Rusal is the largest aluminum producer in Russia and a significant supplier to the U.S. The sanctions are directed against Oleg Deripaska, a major investor in Rusal. Presumably his decision to divest will mean Rusal will be off the hook, but that is not certain at this point. Copper and nickel prices have been a bit more stable although there have been some wild fluctuations in copper demand over the last few years.
PMI New Orders The slide in the New Orders Index looks worse than it really is. It should be remembered that numbers in the 60s are rare enough and seeing several months in this territory is not to be expected. Even with the slip over the last few months, the index is still over 60 and the overall Purchasing Managers' Index is still in the mid-50s. There is no doubt that numbers have slipped, but there is no danger of an actual collapse at this stage. It appears many companies are watching their cash flow more carefully than has been the case in previous years. That has slowed the pace as far as equipment purchasing is concerned. The most worrying part of the new order index decline is that this is the more future-oriented part of the Institute for Supply Management (ISM) data. Right now, it seems to be pointing to a decline although, once again, these are still very respectable numbers.
Capital Expenditure The level of cap-ex has been rebounding after a precipitous drop at the start of the year. The issue is a familiar one—tax credits and other incentives expire at the end of a given year. That prompts a lot of companies to do their purchasing at the very last minute. This creates a big spike followed by a crash as those that had a desire to do some of this purchasing have now satisfied the itch. It takes a while to get the urge again. The overall growth of the economy has slowed from the pace set last year, but is still in respectable territory. That has allowed the capital expenditure numbers to recover. It is also worth noting that cap-ex data often tracks pretty closely with the level of capacity utilization. Those numbers are very close to what is often considered ideal.
Spring Was Nice but It Came on a Tuesday and I Missed It Yikes! What a weather year this is. In April, we were dealing with very hard freezes—20 degrees and below. Several of our sensitive plants didn't make it through this. Now just a few weeks later, the temps hit 92. The weeds have taken over and I am pretty sure the neighbor's dog was taken hostage by them. I needed a machete to get through the backyard. A week ago, it seemed like there was time to get control of the yard. Now, we are under siege.
I have commented on the "relaxing" avocation of gardening on more than a few occasions. Perhaps for some lucky few it is. These are the people who can either bring in a team of assistants or decide that planting a pot on the porch will be sufficient—not descriptive of this family. The day spent in the garden will end with collapsing in a chair with a handful of Ibuprofen. Each spring, I discover aches and pains in places I didn't even know I had. I have to say it is all worth it in the end when we can finally just sit and look at the fruits of our labor.
This also turned out to be a bad year for the bees. The frozen weather was brutal and my hives of Italians didn't make it. This is a tricky part of the country as it can be far too frigid for the Italians, but too hot for the Carniolans. Last year was hot, so I opted for the heat-tolerant species—just in time for sub-zero temperatures. Oh well—better luck next year!