Strategic Global Intelligence Brief for May 2, 2018
Short Items of Interest—U.S. Economy
Wage Hikes Finally Showing Up It has taken an inordinately long time, but there is evidence at last that wages are going up at a pace commensurate with the growth of the overall economy—this could be worrisome. For the last few years, the pace of wage growth has been weak—no more than around 2.3% on an annual basis. That is simply not the pattern expected given the very low rates of joblessness. The latest data shows that wages are growing at a 2.9% pace, closer to what the Philips curve would seem to call for. The problem is that this wage growth may now start to add to inflation concerns as it is taking place at the same time that commodity prices are rising (especially industrial metals and oil).
Mixed Signals for the Fed On the one hand, there is the mounting inflation threat—everything from oil prices to steel prices to wages. This would signal to the Fed that inflation is on its way. Now would be a great time to try to nip the issue in the bud with rate hikes designed to cool things off a little. On the other hand, there is the uncertainty that has been introduced by the Trump administration over trade and tariffs. The manufacturing and construction sectors are already feeling the impact of higher steel and aluminum prices. Now, they are contending with higher fuel costs. That more expensive fuel is hitting both transportation and agriculture. It may even have a dampening impact on consumers as they consider summer vacation plans. This uncertainty could cause the Fed to delay efforts to slow the economy down. We may get a little clarity this week, but it is likely the Fed will just have to wait to see which trend starts to dominate.
Fixing Education in the U.S. If ever there was a disconnect, it is between the demands of the business community and the education system. The most chronic complaint from business is the lack of skilled workers. They lay the blame on the schools. At the same time, the education system in many states has been systematically stripped of the money and resources needed to meet the need. The time has come for serious dialogue between the schools and the business community that relies on their output.
Short Items of Interest—Global Economy
Putin Shifts Gears Russia's economy is in shambles and prospects are worsening. The sanctions and other punishments have been having an impact serious enough that it has started to affect military spending. The public is even more annoyed by the lack of economic progress. Not that any of this has affected Putin's hold on power, but it has made the population restless. The appointment of longtime aide, Alexei Kudrin, to a new post designed to mend fences with Europe and the U.S. signals that Russia may be reacting to the economic pressure imposed by the western states. It is not clear yet what it will take to get sanctions removed, however.
Oil, Iran and Nuclear Deals What will happen if the U.S. pulls out of the deal with Iran over the development of nuclear weapons? There is no provision for an automatic resumption of U.S. sanctions and it is clear the European signatories will not impose them. Iran may or may not elect to resume its efforts, but the betting is that it will not. What is almost certain is that oil prices will spike. The nervousness in the market may be enough to drive the per barrel price close to the $100 a barrel mark—at least in the short run.
Political Crisis in Armenia After the surprise resignation of the former Prime Minister Serzh Sargsyan, it appeared the opposition leader—Nikol Pashinyan—would become the next leader. However, the ruling Republican Party has refused to approve him in Parliamentary votes. He is now calling for a national strike. The streets have filled with protestors demanding he be approved as the new PM. The leaders of the Republican Party were not prepared to deal with the resignation of Serzh Sargsyan and had no alternative candidate.
Some Mysteries in the Credit Managers' Index This Month
There are some growing signs of economic distress showing up. Now we can add the results of the latest Credit Managers' Index (CMI) to that list. The numbers are not awful at this point—many of the indicators are still solidly in expansion territory, but the warning lights are starting to blink. In just the last few weeks, there has been more concern over inflation and the eventual Fed reaction. Yields for the 10-year treasury just broke through the 3% psychological barrier. That has many wondering what interest rates will look like. Some of that caution seems to be showing up among credit managers as well.
Analysis: The combined index number slipped to 53.7, a low not seen since May of 2017—nearly a year ago and before all the growth activity taking place at the start of this year. The index of favorable factors remains in the 60s, but just barely at 60.2. The March reading was 63.2. There is really no cause for much alarm at this point as 60.2 is still an awfully strong number, but the trend is not what would be preferred. The sales reading actually went up from 64.1 to 65.8, while new credit applications stayed stable with a reading of 62.2 following last month's 62.7. The stunner this month is in dollar collections. The collapse is almost hard to fathom as the reading fell out of the 60s with a resounding thud—all the way to deep into the contraction zone (a reading under 50) at 46.7 from 59.6. This may be an anomaly, but it would be an enormous change and signals a level of distress that was not anticipated. The amount of credit extended also remained about as it has been at 66.1 compared to 66.2 in March.
The combined score for the unfavorable factors also showed some distress as well, with a reading of 49.4 compared to 50.6 the month prior. The last time the index was in the 40s was in July of last year. All but two of the readings are now in the contraction zone. The rejections of credit applications slipped a bit, but stayed above 50 with a reading of 51 after March's 53.3. The accounts placed for collection reading slid out of the expansion zone as it fell to 48.7 after having been at 50.4. The disputes reading actually improved a little, but remained in the contraction zone with a reading of 48 after falling to 47.7 in March. The dollar amount beyond terms data also fell again and now sits at 46.4 as compared to 47.2. This is the lowest point reached since May of last year. That constitutes another warning shot. It looks like creditors are having more challenges as far as staying current, which may be contributing to the very weak dollar collection numbers. There was also a reduction in the numbers as far as dollar amount of customer deductions (from 49.8 to 48.4). The only other reading that has managed to stay in the expansion zone was filings for bankruptcies as it went from 55.2 to 53.8.
The overall sense of the data this month is reduced enthusiasm. There is not an immediate crisis manifesting as long as the favorable factors are in the 60s, but the collapse in the dollar collection numbers is worrying. This may be nothing more than a timing anomaly—there have been other examples of this in the data this year. Extreme weather has taken its toll and there has been a lot of uncertainty regarding trade and tariffs. The fact is that both dollar collections and slow pays have been volatile this year. This may be another example of that volatility. As the economy has recovered with some speed, there have been companies that have been forced to try to keep pace with their competitors, but really don't have the ability to do so without lots of credit. Now they may be struggling to keep on top of that debt. The economy as a whole has continued to grow, but some sectors have not been as robust as others—retail is still down and there have been stutters in manufacturing and export-oriented sectors.
Manufacturing Sector There has been a lot of turmoil in the manufacturing community of late. The announced steel and aluminum tariffs have hit costs very hard. Even with all the exemptions that have been subsequently announced, there is concern that prices will continue to escalate. At the same time, there has been a general sense that oil prices are on their way up to old highs. Nearly every manufacturer has been reporting that logistics costs are going way up as well. This is on top of the ongoing issue of labor shortages, which has only become more acute with each passing year.
The combined score for manufacturing slipped from 55.2 to 54, taking the numbers back to where they were in January. This is not a massive decline as of yet, but it had been hoped that positive trends would start to dominate by this time. The favorable factors fell out of the 60s, but not by much as the latest reading is 59.8 after being at 62.4 in March. The unfavorable index stayed almost the same as last month—50.1 after a reading of 50.3—still hugging the expansion zone by the skin of its teeth.
The sales category improved from 62.5 to 66.2. That takes these numbers close to what they were in June of last year (66.9). The new credit applications numbers shifted down a little, but stayed in the expansion zone by moving from 62.4 to 60.8. The big change was in dollar collections where the numbers cratered. The reading was at 59.5 in March and is now at 46.1. Similar to the combined score (59.6 to 46.7), this is a very dramatic change. It is not altogether clear this change is permanent—there are some anomalies that may have played a role. The amount of credit extended also improved a little to 66 from the previous month's reading of 65.3.
The data in the unfavorable categories stayed about the same with most of the readings close to expansion status, but still stuck in the contraction zone. The rejections of credit applications shifted down from 54.1 to 52.4, but at least it is still in expansion territory. The accounts placed for collection dropped out of the expansion zone with a reading of 49.8 after being at 51. The disputes category improved, but still languishes in contraction territory as it moved from 46 to 48. The dollar amount beyond terms stayed about where it was last month with a reading of 46.8 compared to 46.5. The dollar amount of customer deductions dropped very slightly from 48.7 to 48.4—essentially staying the same. Finally, the filings for bankruptcies reading went from 55.6 to 55.1. In all, these numbers remained very similar to what they have been—not really great but not getting appreciably worse.
The sense is that there may be a breather under way—a time that manufactures are taking to sort out some of the issues surrounding trade wars and tariffs and the overall expected pace of growth now that interest rates are headed up and markets are getting nervous.
Service Sector The service category followed the same trend as manufacturing, but with some fairly significant differences. The overall score dipped from 56.1 to 53.4. That takes the numbers back to what they were in December—still reasonably respectable. The index of favorable factors remained in the 60s, but it was less robust than in March as it slipped from 63.9 to 60.6. The index of unfavorable factors slid out of the expansion zone by moving from 50.8 to 48.6—a little distressing.
The sales category fell slightly from 65.8 to 65.5, so there was very little change noted and the numbers remain very strong. The new credit applications category went from 63 to 63.6, a very positive trend as well. Just as with manufacturing, the real damage was done in the dollar collections category with a precipitous drop from 59.8 to 47.3. Also, as with manufacturing, it is not really clear what has been behind this cratering. There are some anomalies that can be attributed to weather and some of the overall uncertainty on trade and tariffs, but time will tell. The amount of credit extended slipped from 67.2 to 66.2, but these are still very strong numbers.
Some of the more dramatic activity was seen in the unfavorable categories. The rejections of credit applications fell under 50 with a reading of 49.5 as compared to the 52.4 notched in March. The accounts placed for collection slipped deeper into contraction territory with a reading of 47.7 as compared to the 49.7 last month. There was also a dip in the disputes reading (49.3 to 47.9). The dollar amount beyond terms also fell back a bit from 47.8 to 46. This number is often related to dollar collections data and this suggests that some of the expansion efforts of the service sector have been premature—especially in retail and to some degree in construction. The dollar amount of customer deductions also experienced a bit of a reversal with numbers this month at 48.3 after being at 50.9 and in expansion territory the month before. The filings for bankruptcies stayed in expansion territory, but slipped a bit from 54.8 to 54.2. The biggest concerns are in the retail sectors and construction, but even health care is feeling these pressures.
The big mover this month was dollar collections as this helped drive both favorable and nonfavorable readings down and shoved some back into contraction territory.
Concerns Emerge in Latest Purchasing Managers' Index
It is not only the CMI that is showing strain. The latest iteration of the Purchasing Managers' Index (PMI) as produced by the Institute for Supply Management has declined for the second month in a row—dropping two points to read 57.3. This is certainly not the hoped for trend given the index was hitting a 14-year high as recently as February, but it is important to remember that anything over 50 is indicative of growth. A reading of 57.3 is certainly comfortably in that category. The bigger issue is why the index has dropped. This has been pretty clear from assessing the commentary by those responding to the survey. The catch-all phrase is "input constraints." That includes everything from the chronic (and worsening) labor shortage to the impact of the steel and aluminum tariffs. In more general terms, there is far too much uncertainty, which serves as a brake on growth all by itself.
Analysis: Prices for steel and aluminum have already spiked despite the fact that over 85% of steel imports and 90% of aluminum imports have not been affected by the tariffs as of yet. The majority of the countries that export to the U.S. have been given exemptions to the tariffs, but these have come with expiration dates and that creates the uncertainty. The EU and other nations that had been granted exemptions were on the brink of losing that status earlier in the week. At the last minute, another one-month extension was granted. This kind of last-minute histrionics drives business to distraction as it makes even short-term planning impossible—much less longer-term strategy. On top of this uncertainty, are fears of higher fuel prices as the per barrel price has risen into the $70 range and could head higher still. That has already triggered fuel surcharges by many of the transportation companies; higher cost logistics has become a major concern.
Then, there is the ongoing issue of manpower. This has been a concern for years—the issue just becomes more and more acute. The fact is that retirement is hollowing out the manufacturing workforce and making the challenge ever greater. The lack of new people entering the field with the needed skills has been a complaint for decades. Now, the issue has reached crisis levels with Boomers retiring at a pace of 10,000 per day—close to 3.5 million a year.
The Delicate Nature of Staying in Business
There are many myths and misapprehensions regarding "business." Not that most of the readers of the this newsletter possess these, but we all know people who seem to have no real sense of what it takes to run a successful business of any size. In the course of my travels and talks, I spend a lot of time with small- and medium-sized business owners in a wide variety of sectors—everything from manufacturing to construction to agriculture and retail. They all face similar issues as far as meeting consumer needs, handling their employee challenges and organizing their day-to-day activities. One other issue they all share is general ignorance regarding what running a business is like. Many assumptions are made that are way off the mark—especially by the political leaders, it seems.
It is assumed that business makes money hand over fist and can therefore handle any level of additional taxation without impact. I once had a conversation with a member of the House of Representatives who has been in political office for the better part of four decades who declared with supreme confidence that most businesses had 70% profit margins. That is not a typo. When I pointed out that the average profit margin for small business was less than 7.5%, he demanded to know where I got this information. I told him it came from a government office across the street from his. For many sectors, that margin is considerably smaller than this. The bottom line (literally) is that even small tax hikes can reduce that margin to the point it no longer makes sense to even be in business. The second-biggest concern is regulation that ends up costing a company large sums of money to comply. The overall result is that much of what a small- and medium-sized business makes is siphoned off to taxes and regulation, leaving less for hiring and expansion. Obviously, some taxation and regulation is expected, but in too many situations, too little consideration is given to the overall impact of what some would assert is a minor change.