By Chris Kuehl, Ph.D., NACM Economist—
Short Items of Interest—U.S. Economy—
Markets Hoping for the Best—
Investors appear to be a happy and confident lot these days as they continue to believe everything is going to turn out just fine. There have been ample signals as to the potential for a serious slowdown and maybe even a full-fledged recession, but the markets continue to barrel along. The expectation is some kind of deal will be worked out to end the trade war between the U.S. and China and there is confidence that central banks (especially the Fed) will keep lowering rates. This is despite much evidence to the contrary. The deal with China has been promised for months, yet nothing has transpired. The Fed has made no secret of its satisfaction with where rates are right now. Of course, all this can change in an instant, so perhaps optimism still makes sense.
There is not a lot of data available this week with the impending holidays, but there will be a report from the Conference Board tomorrow which will provide some insight into consumer confidence. The last couple of months have registered a decline as consumers have started to worry about the impact of the trade wars and start to get concerned about the impact of politics on the performance of the economy. The expectation is the survey will show a gain in overall confidence as this is the holiday season and the retail numbers have been pretty solid thus far. The usual factors that depress consumers are still not in evidence—namely the rate of joblessness. As long as low unemployment numbers hold, the consumer is in good shape.
Dramatic Shift in Energy Sector
For the first time in over 70 years, the U.S. exported more crude oil than it imported. The U.S. has been largely energy independent since the development of shale oil, but now the U.S. is the dominant exporter as well. Shale gas has largely replaced coal for the utilities and gas may start showing more gains in transportation as well. This puts the U.S. in a rare position as arbiter of global oil prices, but at the same time, the U.S. now has a vested interest in promoting higher oil prices in general and could use its influence to push the price per barrel to closer to $100. It is no longer preoccupied with the consumer point of view.
Short Items of Interest—Global Economy
Global Trade Drops Drastically
The multiple trade wars and challenges facing the global economy have taken their toll and there seems no end in sight. The level of global trade plunged again in September. There had been some hope conditions would have improved as the U.S. spending season got under way. The U.S. has been affected to some degree as exports account for about 15% of GDP, but for nations like Germany, the crisis is immediate—they rely on exports for up to 55%. The impact on other export-reliant states has been severe.
Tories Try to Moderate
The manifesto released by the British conservatives is unlike anything that has come from the right of late. The right-wing staples have been cutting taxes on the wealthy and corporations, and at the same time, cutting social services, health care and education. The new Tory plan calls for no such tax reduction, but expanded spending on social services, health and education. All of a sudden, it is positioning itself as a moderate party—on everything except Brexit.
Another Reversal for the Left in Latin America
By a very narrow margin, the conservative opposition in Uruguay seems set to take the presidency. Luis Lacalle Pou is a 46-year-old lawyer and son of a former president. and has a 30,000-vote lead. The left-leaning coalition that has been governing has not been able to deliver on its promises. It has been judged to have become too close to the leftist governments in Bolivia, Argentina, Venezuela and Ecuador. The population now wants to return to the center right—at least for the time being.
Hong Kong Elections
For the past decade or so, the local elections in Hong Kong have been about as meaningful as the local race for city dog catcher. The vast majority of the population rarely even bothered to vote as the power of the local government is almost nonexistent. The "issues" raised were the kinds of things a homeowner's association would fixate on—the state of one's yard, barking dogs and whether a place needed to be painted. All the real decisions about governing remained in the hands of the Beijing authorities. This time was very, very different with a record turnout of close to three million people. There was even evidence of attempts to stifle the vote in areas that were known to be anti-Beijing. In the end, the voters put the opposition candidates in power in 12 of the 18 districts. Only four years ago, opposition candidates won 100 seats as compared to the 278 they now hold. These councils hold no more power than they ever had, but the voters have sent a very clear message of support for the protests. That presents Beijing with very serious problems.
Analysis: There are only two scenarios on the table at this point. The first and most likely is a very bloody confrontation between the demonstrators and the police/military. This would likely result in an intensified series of protests, but in the end the authorities have the manpower and resources needed to crush the movement. The aftermath would be very bad for Beijing as it would essentially mean the end of Hong Kong and its role as a finance center for Asia. Many banks and other institutions have already made plans to decamp to Singapore and other cities. That process would accelerate. The world would react with varying degrees of hostility, but just as with the end of the Tiananmen Square protests, the whole issue would soon be swept under the rug. In the short term, an attack on the protests would make it harder for Trump to make a deal, but he has not shown much concern over repression in other nations, so an attack by the Chinese might not really matter.
The second scenario is in the hands of the protestors. They would have to agree to sit down with the Beijing authorities and accept some partial deal regarding reform. Thus far, China has agreed to remove the threat of extradition and they have removed Emily Tam as the leader of Hong Kong. The demands that have been made since are far less focused and call for varying degrees of autonomy and free elections. The Beijing offers fall far short of these demands, but are about as far as the Chinese can go. The sense at the moment is that the protestors will not back down. It isn't even clear that they have a leader who could make a deal.
What Does a Post-Brexit Trade Relationship Look Like?
The Brexit agony in the U.K. continues to fester. At this point, the elections do not seem to provide an answer to what happens next. Neither the Tories nor Labor look to be able to form a government; voters do not seem to have a clear opinion on Brexit. The same regions that supported it during the referendum support it now and the same regions oppose it. One of the points that has been clear throughout the discussion is that both the U.K. and EU would like to preserve the trade relations that exist between the two. The issues that have motivated the Brexiters have been social—immigration and the impact of Europe's cultural rules on Britain. Now that it seems inevitable that another stalemate is developing, there are some renewed attempts to hammer out some kind of trade deal.
Analysis: European leaders are suggesting a separate trade deal can be explored once the dust settles from a Brexit, but they have stressed that any such deal will have to comply with European standards as far as labor and environmental laws as well as the host of other regulations that order business relations. There are many in the British business community that supported a Brexit on the basis of wanting freedom from these European rules, but the majority of the U.K. voters did not react to these issues—their concern was immigration and the supposed assault on British culture. There was concern about lost jobs and changing societal norms, but less popular interest in rules and regulations.
The challenge now is getting the business community on board regarding a new trade agreement. If there is to be a Brexit, will a replacement trade arrangement take its place? The most vexing issue still hangs over all these negotiations. What will done about Northern Ireland. The EU will not accept a loose border that would allow companies in the U.K. to use Ireland to thwart the Brexit withdrawal, while the U.K. doesn't want a hard border that would likely lead to intense unrest in Ireland and Northern Ireland. The trade deal might be a way to address the Irish border question, but there have been few detailed plans developed for how that would work.
For the last several months, the theme for the majority of my presentations has been whether the U.S. was heading for a recession in the near future. There have certainly been indications that such a fate was possible—everything from weaker readings from the Purchasing Managers' Index to slowdowns in durable goods orders, factory orders, reduced industrial output, reduced capacity utilization and so on. At the same time, there have been signals that economic growth will be maintained—solid rates of unemployment, confident consumers and good retail sales numbers, and GDP growth rates that have exceeded expectations. It has been my assertion that a recession is not imminent and at this point it is not likely. This is only qualified good news as the economy seems to have settled into a period of mediocre expansion.
Analysis: Most of the readings are suggesting that business and investment in general has settled into a pattern of caution and trepidation. The latest assessment of the rate of capital spending indicates there isn't much taking place. In the third quarter, the rate was only up by 1%. It would have been even lower if there had not been some expansion on the part of behemoths such as Apple and Amazon. The latest iteration of the Forming and Fabricating Job Shop Consumption Report from the Fabricators and Manufacturers Association also indicated that capital investment is down. The Federal Reserve released their assessment of business borrowing. It is also down to near recession levels.
There are three factors that seem to be weighing on the business community at this point. The first has been an issue for the last two to three years and has been building steadily. The trade and tariff wars have been destroying supply chains and ruining expectations as far as costs. It has been more than difficult to replace China as a supplier. The second issue has been the impending political season as expectations have been thrown into doubt. Normally, an economy as healthy as this one would ensure continuity as voters would support the incumbent. Trump's popularity is far lower than would be expected and that makes the election a toss-up. The business community is not happy with either party's platform at the moment, which creates unease. The third worry stems from the strains of the labor shortage. Expansion plans have been placed on hold due to the lack of workers with the required skill and experience.
The Housing Bust on the Horizon
For years, the housing sector has watched the behavior of the Millennial buyer with some concern. What will they do? When do they decide that it is time to move out of their parent's basement or the loft? When will they join the ranks of the single-home buyer? Now, there is another worry in the housing sector. It also relates to the actions of the Millennial as well as the Baby Boomer. It is estimated that over 20 million single-family homes will be hitting the market in the next decade or less. These are the homes that will be vacated by the Boomers as they opt for residence in senior living alternatives or because they have passed away. Very few of these homes will be passed on to children as these offspring either have their own homes by now or are simply not interested.
Analysis: There will be a glut of existing homes on the market. The majority of them will be in the "wrong" place or lack the appeal of the current home. Older suburban neighborhoods will be hard hit and cities where economic growth has stalled will be saddled with housing stock that will not sell. People trying to sell in these areas will find low prices, which may compromise their plans to relocate. Communities will experience a deteriorating tax base. In past years, this glut of homes was addressed to some degree by the arrival of immigrant communities that were attracted to the lower prices, but the current attitude towards immigration has compromised that option for many communities.
Not All Bad News
There are many indicators suggesting a slowdown in the economy—if not a recession. There are also signs that suggest not everything is bleak. The latest edition of the HIS Markit version of the Purchasing Managers' Index (PMI) registered a more robust reading than expected—51.9. This is in contrast to the 50.9 that was notched in October. This is certainly encouraging, but their version of the PMI has been consistently higher than the version from the Institute for Supply Management
Analysis: The truth of the matter is that numbers in the high 40s and numbers in the low 50s are not all that different in terms of what is being indicated. The distance between contraction and expansion is narrow. Once the numbers get to the mid and upper 50s, there will be an opportunity to relax, but by the same token, numbers close to the mid and lower 40s will be a real cause for some alarm. The sense at the moment is that economic growth is fragile and the usual inhibitions are playing a role.
The markets have been counting on some developments that have yet to materialize. Every week, there is another statement from Trump asserting that a trade deal is "close" and every week there is another reason to delay. The markets are responding to each of these statements like Pavlov's dog, but at some point, there either has to be a deal or the markets will stop responding to the tease. This week, the inhibition is the events in Hong Kong, but there have been dozens of excuses for stalling the deals. Most of these issues are still unresolved.
I Am Sure It Is a Communist Plot
I recently acquired a few new items with which to festoon my yard for the holidays. I am sure the neighbors wince this time of year as I endeavor to lower the property values. I am not at all sure why I feel compelled to do this every year. It probably has to do with my having the sense and taste of a six-year-old (ooh—sparkly lights). At least this year, my granddaughter and my three grandkids are coming up from Florida and I have an excuse for all the yard art. As I spent part of Sunday putting these things together, I was once again struck by the fiendish nature of assembly instructions. I am sure this is part of a master plan to render Americans catatonic with frustration.
The instructions were simple enough: "Insert tab A into slot of right kind." OK. Next there was this helpful comment. "Hold part B for use for holding. Part B is not for use." Followed by, "Place hand, use other hand for steady, insert, twist away, use enclosed tool." At this point, I want to add my own instruction: "Take sledgehammer to whole project and walk away." Finally, there was this closing admonition: "Do not take object to children unless injury is planned." I think it was nice of them to give me choices. If I want to injure children, I am still allowed to do so—I just need to plan it.