Short Items of Interest—U.S. Economy
Consumer Confidence Rebounds
Earlier in the year, consumers looked worried about what was coming up and this was affecting their mood. Both the Conference Board and the University of Michigan surveys indicated a slump as consumers worried about trade wars, potential inflation threats and an end to job growth. These concerns seem to have faded for the time being. That has retailers assuming the summer will be more robust than originally expected. It is important to note that few things shift as quickly as does consumer confidence. Thus far, those tariffs on Chinese goods have not affected consumer prices. This will change in the next few weeks. That is when consumers may start to worry about trade fights again.
Home Prices Start to Stabilize
The housing market has been struggling of late—especially the pace of new home building. The majority of the construction has been concentrated in the more expensive categories; not at the starter home level or even at the intermediate price range. The growth of the stock market has been propelling growth at the higher end. Now that prices are starting to settle down and even decline in some markets, there is an expectation that building at the lower end of the market may start to pick up. It has also been noted that apartment rents have been climbing fast, which has made buying a home more attractive financially.
Fed Rate Cuts Propel Bond Yields
Investors are making new assumptions. A few weeks ago, the prevailing wisdom was that the Fed would stand pat through the remainder of the year and into next. There were even a few who thought a rate hike would be possible. Now the thinking is that a rate cut or two is likely by the end of the year as the Fed starts to worry about the slowdown in the global economy and the impact of the U.S.-China trade fight. This has pushed Treasury yields down to levels not seen since 2017 and has reignited the debate over inverted yield curves and the threat of recession.
Short Items of Interest—Global Economy
Modi's Challenge
The easy part may be over for Narendra Modi. His landslide election to a second term was rooted in ardent Hindu nationalism and owed as much to the poor campaigning of Rahul Gandhi and the Congress Party than to anything else. Now that Modi has another term, the economy has returned to center stage and he will be expected to deliver on the many promises made on the campaign trail and in his first term. This is going to be very hard as there is no consensus on what path to take. There are strong protectionist voices in Modi's Bharatiya Janata Party and strong voices asserting that globalization is the proper path.
Rare Earth Threat
China controls around 80% of the global supply of rare earth materials. The threat is that China will stop exporting them to the U.S. These are used in any manner of high-level electronics so the loss of access would be significant. The problem for China is such a ban would only encourage development elsewhere as 60% of these materials are outside China. The Chinese advantage is their processing costs are very low. If they ban exports, the prices will rise and that will encourage other producers to engage. They then become a permanent competitor to China and it is unlikely that China will be able to maintain market share.
European Labor Shortage
Recent research indicates that one in four small- to medium-sized companies in France and Germany are unable to find workers needed. This has caused these companies to restrict their growth. Both Germany and France (and others in Europe) have people who are unemployed, but they lack any of the skills needed to work in these companies. These are overwhelmingly in manufacturing, construction and transportation; the same sectors that are facing labor shortages in the U.S.
European Leadership Turmoil
There has rarely been a more confused political landscape in Europe and rarely at a more critical time. The economic growth in the eurozone has been anemic at best and the Brexit mess is only dragging this growth down further. The rise of the populist right has affected every nation. There are dramatic changes in the relationship between the U.S. and Europe. Russia is still a major threat and China's dispute with the U.S. has affected Europe as well. Issues such as immigration continue to dominate the agenda and there has rarely been less political stability as these issues are developing. The majority of the leaders in Europe are lame ducks to one degree or another. That is affecting the future leadership of the region.
Analysis: Prime Minister Theresa May has resigned as party leader in the U.K. and will step down in June. She is likely to be replaced by the mercurial and virulently anti-European foreign minister, Boris Johnson. German Chancellor Angela Merkel has already stepped down as head of Germany's Christian Democrats. That has compromised her influence as far as who will head the European Central Bank (ECB) or the European Commission itself. She has been pushing for Manfred Weber for the latter post and Jens Weidmann for the ECB. Neither candidate is being welcomed with open arms by the rest of Europe. French President Emmanuel Macron and Spanish Prime Minister Pedro Sanchez both oppose Merkel's choices. The current head of the European Council is Poland's Donald Tusk who will be stepping down in a few months.
The list of new national leaders is very long and complicates any sort of policy development on a wide range of controversial and urgent questions. In addition to the departure of May, Merkel and Tusk, the list of departing leaders includes Prime Minister Charles Michel of Belgium, as he has been unable to deter the growth of Flemish nationalists; Lithuania's President Dalia Grybauskaite, as her term limit kicks in; and, Finland's Prime Minister Juha Sipila, as he will lose his post to the new center-left coalition. Three important leaders will be facing new elections soon. All three are facing stiff opposition: Prime Minister Alexis Tsipras in Greece, Prime Minister Lars Lokke Rasmussen in Denmark and Minister of Defense Leo Varadkar in Ireland. When Chancellor Sebastian Kurz lost his vote of confidence in Austria, he was replaced by Acting Chancellor Hartwig Loger, but only until a new election. Kurz had been an ally for Merkel and other members of the center right.
The votes for the European parliament confirmed what many had been seeing in the national elections over the last few years. The voters are fed up with the traditional parties—center left or center right. They are not at all sure what they want instead, but there has been support for all kinds of alternatives. Populists like the Five Star Movement in Italy have gained and so have rabid nationalists such as the AfD in Germany or Republicans in the U.K. There were also big gains by the Greens and various extreme-leftist parties. The voters were in a mood to protest and not to choose another course. There is major difference of opinion as far as what any nation should be doing differently—just agreement that something different needs to happen. The major issues range from the highly emotional such as immigration to the imminently practical such as jobs and economic growth.
Looking ahead, it is likely that the big names in European politics will be French President Emmanuel Macron, Spanish PM Pedro Sanchez, Italian Deputy PM Matteo Salvini, Germany's head of the Christian Democrats Annegret Kramp-Karrenbauer and Boris Johnson should he become the next British PM.
Mollifying China
Attacking China has always been popular with politicians and not just in the U.S. The new Brazilian President Jair Bolsonaro has been following in the footsteps of Donald Trump as far as blasting China. There have also been many African leaders who have expressed deep frustration with the Chinese, while the populists in Europe have been critical as well with Boris Johnson getting more aggressive by the day.
Analysis: All this diplomatic attack has been hiding a whole other effort—akin to watching synchronized swimmers. What happens above water obscures what is going on below it. All of these countries have been actively courting and assuring China that there remains a desire to do business with China despite all the rhetoric. The reality is that no nation can afford to turn its back on the world's second-largest economy. Even the U.S. seeks to avoid a complete split. It is true that most nations have complaints about Chinese trade policy, but that doesn't alter the fact that it is a market that few can afford to walk away from.
Putting the Dismal Back in the Dismal Science
It is time for some good old-fashioned sober reflection on all those things that could go wrong with the economy and plunge us into another crisis on the scale of the Great Depression of the 1930s. OK—so things are not really likely to get that bad, but there is plenty to worry about nonetheless. We are starting to hear the rumblings from within the investment community. It is important to note that this is a notoriously fickle group prone to both wild enthusiasms and fits of despair, but these shifting attitudes tend to demonstrate the characteristics of a self-fulfilling prophecy. Much of what is propelling the current sense of impending doom is bond yields. They are as low as they have been in years. There is most definitely a reverse yield curve in place as many investors are showing enough concern that they are heading towards the security of bonds as opposed to the equity markets.
Analysis: People worry about a lot of things. There are always the "black swan events" that people expect, but where timing and impact are in question. That said, there appear to be three factors that worry the investors and analysts the most. These are the factors that could push the markets down drastically and impact the overall economy in a negative manner—perhaps in time to be an issue in the 2020 elections.
At the top of the list is the trade war between the U.S. and China. There was an assumption among investors for the better part of the last year, but now this assumption is proving to be inaccurate. The expectation had been that cooler heads would prevail and that a deal would be struck. All of the Trump fulminating and drama was nothing more than negotiating tactics. Surely, nobody would really plunge the U.S. into an economic crisis on purpose. It has now dawned on the investor and the business community that this conflict is not about economics or business—it is political and personal. Trump is quite willing to watch the U.S. economy take a big hit as long as it seems to hurt China more. Not only is this trade dispute going to be protracted, it is likely to accelerate as both nations test the resolve of the other. The assumption is these tariffs and other barriers will start to heavily impact the consumer this year.
The second issue that seems to be affecting the mood of the investor is employment. This seems a bit odd given the very low rate of joblessness, but there are worries regarding how long this lasts and what reactions will be if and when the rate starts to climb. There are also concerns regarding the fact that many of the jobs that have been added in the last few years have been low-paying service sector jobs as these are not the most active of consumers. The concerns extend to the fact that there is a persistent job shortage in a variety of sectors such as manufacturing, transportation, construction, health care and others. The fact that 10,000 Baby Boomers are retiring every day is a worry as well. In short, there is certainly good news when it comes to the rate of unemployment, but there are also plenty of factors to be concerned about. Some of these are affecting overall expectations.
The third worry is that global economic drag will catch up to the U.S. sooner than later. It is great the U.S. economy is doing so well, but these gains are taking place despite the fact that one of the three legs of the economic stool is broken. The consumer is still in a boisterous mood and the business community is still investing at a brisk pace, but foreign trade is way down. This is traditionally 15% of the national GDP—somewhere around $2.7 trillion dollars' worth annually. This is a very weak sector right now. Europe is barely scraping along at less than 1% growth and Japan is not any more robust. The two most important trading partners for the U.S. are Canada and Mexico. Both are experiencing weakness (Canada from low commodity demand and Mexico from reduced manufacturing activity).
None of these seem imminent threats—at least not in the next month or two. They are, however, worrisome enough that investors are retreating and hedging—moving into bonds and away from equities. Caution is now the watchword. That position will be reinforced if the Federal Reserve appears ready to boost interest rates or if political infighting eliminates Congressional ability to accomplish anything at all as far as boosting the economy.
Oil Over-Supply Accelerates
The price per barrel for oil has fallen by 11% in just the last several weeks; not an expected development this time of year since this is the start of the summer driving season. Everybody knows this is when gas prices go up. Demand is high and usually supply is commensurately low. Not this year. Supply levels are as high as they were in 2017 and they are going up. This is not something expected either as there have been plenty of shocks to the oil market that should have resulted in reduced output. The Russians and OPEC members agreed to reduce their production, civil war in Libya has reduced their output and Iran has been affected by the increased sanctions from the U.S. Venezuela has all but ceased production and so on.
Analysis: The difference is that U.S. producers are stockpiling far more than usual. This is a pattern that will likely continue for a while. The U.S. production began to spike when oil prices rose earlier in the year. The U.S. can adjust production levels far faster than almost any other producer and it took advantage of the spike. Now it is simply gobbling up market share from those producers unable to gear up as quickly. Ultimately the U.S. producer would like to see oil prices near $80 a barrel. The current price is well below that and U.S. production will adjust downward over the next few weeks.
Life in Tornado Alley
It came real close last night. Forgive me if I make light of the twister threat in this piece. As a lifelong resident of Kansas City, I have grown up with these storms and know full well the tragedy and violence they bring. But this is the Midwest and wry humor becomes a defense. We joke that the sirens only sound so that residents have time to find their cameras. We have trailer parks that are actually named "Tornado Bait Acres." Last night, we were settled down to watch some episodes of "Miss Fisher's Murder Mysteries" when those sirens went off and the local channels devoted themselves to the advance of the storm. It was a massive tornado—nearly a mile wide. It stayed on the ground for almost 20 minutes. At one point, it was heading straight for our neighborhood, but it drifted just north after destroying several other neighborhoods and small towns.
The mission in our home was getting the feline five into the basement area. This is a space below the three-car garage. Several years ago, my stepson converted it into a replica of a French village square. I am not kidding. He was between jobs and we needed a project that would occupy him for a while as he would not accept money any other way. This room has storefronts (wine shop, bakery, fruit and vegetable stand, bookstore, café), a cobblestone street and a rock wall. The whole thing. It also has massive steel beams that hold up the garage. It is our refuge of last resort. Gathering the clan was challenging as they sensed something was amiss, but with much cajoling and offers of kibble, we got them in. There we all sat waiting for the all-clear. Their reactions varied. The kitten could not have cared less and just played in everything he could find. Smokey basically hid, but Spike and Scoot hung very close to us and kept asking for reassurance. The elder statesman (Sven, at 19) just acted like any other really old man—irritated at the interruption of his routine. Ultimately, we all survived the adventure and got back to Phryne and her sleuthing.