Short Items of Interest—U.S. Economy
How Much Damage Really?
At the risk of sounding like an economist—it all depends. Tariffs are meant to change behavior (one of the basic missions of a tax). In this case, the aim is twofold. One desired outcome is a change in the way China does business; but there is more. There is also a desire to change the habits of the American consumer. For years, there has been an attempt to get the consumer to "buy American," but this appeal to patriotism always came second to the desire to save money. The result was a steady influx of foreign-made goods and the erosion of American suppliers unable to compete. The imposition of a tax on Chinese-made products will create higher prices for the consumer in the short to medium term, but at some point, other nations will seek to fill that gap. Presumably, U.S. companies will do so, but only if they think the barriers will stay in place long enough to justify getting into that business.
Consumer Debt Balloons
It is pretty obvious that government has lost interest in controlling the rise of the public debt as deficits soar alongside the total national debt. It seems that this cavalier attitude is shared by the public as a whole. The rate of credit card delinquency has been rising steadily over the last few years and very rapidly among those under the age of 30. Not surprisingly, the same people who have been running up substantial student loan debts are also running up large credit card debts. They are also the ones having issues with car loans and mortgages. The debt issue among the young is not as simple as figuring a way out of student loan obligations—it seems to be a wholesale inability to manage debt at all.
Global Slowdown More Damaging than Inflation
That is the opinion of Esther George at the Kansas City Fed as well as several others. Despite record low levels of unemployment, there has been no real rise in wages and there has been relatively little pressure from commodity prices. The most important issue is the slowing pace of global growth. The real risk to the U.S. from the tariff policy towards China is that it will work and damage the Chinese economy. A slow China means they buy less from the various nations the U.S. exports to. If these economies slow, the U.S. is affected as 15% of the U.S. GDP is dependent on exports. That is $3 trillion dollars—larger than the entire GDP of either France or the U.K.
Short Items of Interest—Global Economy
Exchange of Provocations in Middle East
The U.S. National Security Advisor has made no secret of his desire to force regime change in Iran. The U.S. has lately sent warships to the region in response to alleged threats. Iran or Iranian-sponsored groups have attacked U.S. allies such as Saudi Arabia through assaults on oil tankers and drone attacks on Saudi oil facilities. It is essentially a mosquito attacking an angry person and the world waits for the response. Will it be an attempt to deal with the attack with overwhelming force or tolerance? Most bets are on the force scenario. That leads to a much-expanded confrontation.
Rapprochement with North Korea at an End?
It was never very clear what Trump was trying to accomplish with Kim Jong-un in North Korea. Analysts warned that Kim was untrustworthy and would never agree to U.S. demands. He has not and has returned to his provocative ways. The U.S. has been getting harsher as well. Now Kim has declared that all progress has been halted and he is free to return to his belligerent ways. With the U.S. locked in a trade war with China, there is no scenario in which China would assist the U.S. with bringing Kim to heel.
Second Brexit Vote?
Using the elections to the European Parliament as a guide, there are slightly more votes in favor of a second referendum on Brexit than there are supporters of a Brexit—around 36% to 35%.
Something for Everyone in This Month's Index
Each month, we assess a series of indices of interest to those in manufacturing for two organizations—Chemical Coaters Association International (CCAI) and the Industrial Heating Equipment Association. These indices are not just specific to the industrial community, they provide a general sense of the economy's performance. What follows is the executive summary and a few excerpts from the total report.
Analysis: The economic news has been really good of late. Almost too good. It is like that patented scene in all horror movies where the ingenue says, "It's so quiet" and the hero responds with, "too quiet." You now know something bad will happen soon. The data from the first quarter has taken many by surprise with a 3.2% growth rate and a 50-year low as far as joblessness is concerned. All without a burst of inflation. What is not to love? The issue now is longevity. How long does all this last and are the reversals already in sight? It would be nice if the data from the CCAI index provided the clues we needed to sort all this out, but there is as much to be excited about this time as there is stuff to worry about—six positive readings and six negative trends.
Given that this is the work of a dismal scientist, we will start with the bad news. The sales of new automobiles and light trucks sank like a rock to perhaps the lowest level in four to five years. There were some weather issues that might have played a role in this negative reading so all eyes will be on next month to determine whether this is a trend or an anomaly. Industrial capacity utilization also fell, but only slightly, and the overall numbers remain very close to the norm of 80% to 85%. There was a dip in metal prices as well, but this seems more related to over supply than a lack of demand. There has been evidence of over-enthusiastic response to global growth numbers last year and early this year.
There was a significant drop in the New Orders Index from the Purchasing Managers' Index (PMI) and that is more worrying than any of the other data points. It remains above the 50-level and in expansion territory, but only by a thin margin. It was only a few months ago that the numbers were consistently in the high 50s and 60s. The gap between orders unfilled and inventory for appliances widened. There was a corresponding dip that may be related to some slowdown in housing. The data from the Credit Managers' Index fell as well. Nearly all of that was due to a slip in the manufacturing side; particularly with the nonfavorable factors such as accounts out for collection and slow pays.
There was plenty of good news as well. The new home starts were not where they had been in past years, but they trended up nonetheless. The big gains have been in the higher-end homes as the buyers have been motivated by the performance of the stock market. The steel consumption numbers are up despite the slowdown in the automotive sector. Commercial construction is back on track in many parts of the country although there has not been a lot of activity to speak of in the public sector (despite all the promises about investing in infrastructure). Tied into some of this has been capital investment. It has been trending up a bit more. Much of that activity has been in the machine acquisition sector as many companies are turning to technology and robotics to cope with the lack of available labor.
The durable goods numbers have been up slightly even without the help of the aerospace sector. There has been a surge in demand for machine tools as well as consumer appliances, but some of this growth may be reactive. As there is anticipation that tariff wars will bite, there has been a lot of advance buying. This has been the story with factory orders as well. This speculative buying will either pay off if the tariffs are imposed or it will saddle companies with excess inventory that will be hard to get rid of—especially if the consumer balks at the higher prices that will be in the offing. The transportation index looks better than many had expected given the issues with ocean cargo and rail. The tariff threats have boosted both inbound and outbound activity for the time being, but that may all come to a screeching halt sooner than later.
New Automobile/Light Truck Sales
The sector has not exactly been a harbinger of things to come, but it has been reflective of the current economic mood more often than not. When consumers are in an ebullient mood, they tend to do four things—they buy houses, they go on more costly vacations, they start to purchase more luxury goods and they mostly decide to buy a new car. There are not many decisions by the consumer that track so well with overall confidence as the one to get a new vehicle. There are times that acquiring a new ride is motivated by something like higher gas prices, but that has not been a major motivator over the last few years. The sudden and dramatic decline in the sales of new autos and light trucks is therefore something to pay attention to.
This could be an anomaly and by next month sales might be back up where they have been for the last few years. But if this is start of a general downward trend, the signal sent is not necessarily a welcome one as it will be due to consumer caution. The next question is what they are cautious about given that most of the indicators are very positive these days—everything from the unemployment rate to the inflation rate.
Industrial Capacity Utilization
Once again, the capacity utilization data has been hovering close to the levels considered "normal," but they have fallen short. The fact is there is nothing magical about the range between 80% and 85% except that this has traditionally separated a period in which there has been too much slack from one where there has been shortages and bottlenecks. If one breaks down the various industrial sectors, there are some that have been in that range and others that have either fallen short or have exceeded that 85% barrier. Thus far this year, the capacity numbers have been very close to the bottom of "normal." That has generally been good news. As long as the numbers are not climbing fast, there is little threat from inflation to be concerned about.
New Home Starts
The rate of new home starts has leveled off a little, but is at the lowest point seen in the last several years. The housing market started to stumble in January and has been falling since. This month there was a tiny bump upwards, but not enough to really change anything. The market for new homes has been divided for the last year or so. Starter home activity has been relatively weak and far from the peak set a few years back. The bulk of the new home market has been in the upscale categories. The starter home driver is usually the rate of unemployment and the rise in wages for the bulk of the working population. The driver for the expensive home is the stock market as this is where the wealth action has been. As the market has boomed, there have been more people with the wherewithal to upgrade their home or decide to acquire a second home. Lately, there has been a slowdown in demand for these more expensive homes as well. There has also been a corresponding decline in demand for existing homes. The fact is that the headwinds that were noted at the start of last year remain in place to one degree or another—lower demand from Millennials, higher prices for homes and somewhat higher mortgage rates.
The level of steel consumption has jumped to levels that few had predicted. This has been a volatile market all year due to the fluctuating status of the steel and aluminum tariffs. The current situation allows Brazil and South Korea exemptions to the tariff. There have also been several hundred individual exemptions granted for steel when U.S. importers can demonstrate that what they require is not available in the U.S. Further exemptions are expected for Canada and Mexico when (and if) the new USMCA is ratified by the respective legislatures of the three nations. This has created a great deal of confusion within the metal-using and metal-producing markets with price hikes that range from 20% to 40%. In the beginning this slowed some of the steel markets, but there has been some adjustment since.
Demand from the automotive sector has been weak—especially lately as demand for vehicles have been falling. On the other hand, there has been more demand from the construction sector. This has always been the biggest as far as steel is concerned. Commercial construction has been rebounding, but public sector work has been far less robust. There has been much discussion of infrastructure needs, but precious little action at the federal or state level.
PMI New Orders
The news from the Purchasing Managers' Index has not been very encouraging over the last several months. The peaks that were being hit commonly last year have become somewhat distant memories. It has been a while since anybody has talked seriously about numbers in the 60s or even the high 50s for that matter. The New Orders Index is flirting with a three-year low as it barely stays above 50 and in the expansion zone. Given that this is the more predictive of the index numbers, this merits some concern. The industrial community is reacting cautiously of late, although it is not altogether clear why. The prevailing theory is that trade wars are making it hard to predict and plan. The reaction by many companies was to load up on goods that might be targeted by one of the tariff moves by the U.S., China, Europe, Canada, Mexico or the dozen or so other nations the U.S. is at odds with. Now they are saddled with inventory they are not sure they can sell and they worry about how long demand will hold up. The overall PMI has also been falling closer to the level of contraction, but thus far, the numbers are still reflecting some growth.
One area of good news has been the unexpected jump in the level of capital expenditures. This latest movement takes the data back to where it has been for most of the last year and starts to make up for the profound loss that took place at the start of the year (after the large increase). To a degree, this has been a return to normalcy after the tax-based incentives that jump started the spending on capital goods. The motivation for these capital expenditures (capex) has been varied—some prompted by tax breaks, some prompted by having a little extra profit to work with and some attributed to companies that have essentially given up finding appropriate workers so they are investing more in technology and robotics. The pace of technological investment has been increasing exponentially over the last few years. That has been driving a lot of the capex activity.
Durable Goods Shipments
The durable goods activity has been holding up pretty well—a brief and small dip followed by another month of gains. This is partly due to the kind of capital equipment that has been in demand, but there has generally been investment in machinery. If there is anything that creates a bit of concern, it is that some of this activity can be attributed to the tariff and trade war concerns as there has been evidence of businesses stocking up on material and machines that might get more expensive later. This would particularly be the case with consumer appliances that have been coming from China. The industrial goods are coming from a more diverse supply chain and may not have been affected quite so dramatically—at least not yet. The other issue is that consumers are slowing down as far as home buying is concerned. That limits some of the appliance demand as well.
I am not really a very good traveler—at least not by myself. When I am with my lovely and curious wife, I am up for just about anything. We explore these new worlds from dawn to dusk and beyond. When I am on my own, I am as dull as paint. Granted, the motivation is different. When I am with her, we are on holiday to some extent. When I am alone, it is just part of the business routine. In talking to others on the speaking circuit, I find there are two kinds of traveler.
The first is like me. We encounter airports and hotel rooms and little else. Those who don't travel much always comment on the exotic locales I frequent and express envy. Just in the last few weeks, I have been in Sarasota, Laguna Beach, Napa, Memphis and Huntington Beach. Did I stroll the beaches? Did I tour the wineries? Did I visit Elvis? The answer would be essentially no were it not for the group activities I was invited to engage with. The fact is I have work that needs to get done whether I am on the road or not. Beyond that, I am awful at doing things alone. Without someone to share these experiences with they have little appeal to me.
The other kind of traveler makes me a little jealous as they are considerably more self-contained. They hit the ground with an agenda that involves cramming as many experiences as they can into their tight windows of opportunity. A guy I shared a program with always brings his golf clubs and finds a new course to play on every trip. One woman makes it a point to hit the local art galleries. It always sounds like a great plan, but I am usually too eager to get back home and rarely linger in a place long enough to partake. Mostly, I take mental note of what I would like to do when I can travel with my spouse!
U.S.-China 25% Tariffs to Weigh on Global Activity
The tariff war has been fully engaged—at least for the time being. The issue has always been more political than economic. Its end will depend on whether President Trump or President Xi Jinping can continue to get more mileage out of the contest than the solution. The impact is not just felt by the U.S. and China as the graph shows. The Europeans and Japanese get caught in the crossfire. So do a host of other nations that depend on either the U.S. or China—they are the first- and second-largest economies in the world after all. The impact of all this will be felt in 2020 to a greater degree than in the previous years.