Short Items of Interest—U.S. Economy
Reactions to Global Tension
The global markets have been roiled quite a bit in the last few days. This is likely to become a pattern in the weeks and months ahead. The sense is that markets are now expecting something bad to develop as a result of political tensions. Almost anything will do as a spark to evoke panic. The feeling is trade tensions will soon explode beyond where they have been. This will damage global growth. Not that this is anything new, but the recent warning from the International Monetary Fund (IMF) reminded investors of the threat. The reactions have been swift, but so has the rebound. The U.S. market was tumbling but regained some footing as the investment community reviewed which threats really seem imminent. There is still no big inflation issue and thus no new action from the central banks for now. This volatility will accelerate as the elections grow closer in the U.S.
Consumer Prices See Only Small Hike
As had been predicted, the level of consumer inflation remains low. That has taken a little heat off the Fed as far as hiking rates. It is still committed to the policy set out earlier, but there is no reason to think it will accelerate. The biggest rise came in the energy sector, but even that has been somewhat subdued of late. The rise was a scarce 0.1% and that translates into a 2% rise year-over-year, the slowest pace seen since February. It had been expected to be a bit more robust than this, but thus far the retailers have been reluctant to drive up prices. The impact of the tariffs, however, has only started to show up. The expectation is higher prices will start to appear towards the end of this year and into next.
The number of Americans filing applications for new unemployment benefits rose last week, but remained historically low and were consistent with a tight labor market. Initial jobless claims, a proxy for layoffs across the U.S., increased by 7,000 to a seasonally adjusted 214,000. In the week ended Oct. 6, economists had expected 208,000 new claims. This is a very tight labor market, but thus far there has not been the kind of wage hikes that would be expected to accompany these numbers.
Short Items of Interest—Global Economy
IMF Backs Fed
Christine Lagarde, the head of the IMF, came to the defense of the U.S. Federal Reserve at the IMF's annual meetings held in Bali for one week starting Oct. 8, calling its interest rate rises "legitimate and necessary" less than a day after President Donald Trump described them as "crazy." As stock markets continued to sell off in Asia, Lagarde called for global leaders not to break the system of international co-operation that she said has served the world well since WWII, and rejected U.S. complaints that China was engaged in competitive devaluations of the renminbi. The Fed has reiterated time and again that rates will go up. Frankly, there is little or nothing the administration can do about it.
Major Stock Sell-Off
Yesterday, stocks were far from an easy game to play. Here is a brief rundown of where the falls for the major Wall Street gauges rank compared to other big one-day drops in recent years. The S&P 500 and the Dow Jones Industrial Average both had their third-biggest drop of this year, and the fifth-biggest of the past five years. One feature of the Federal Reserve's asset purchase programs during the past decade has been lower market volatility, and by some measures, 2017 was one of the quietest years in decades. That all came undone in February when a volatility-induced sell-off generated some of the biggest stock market moves investors had seen in years. A 4.8% drop for the S&P 500's information technology sector, which was recently revamped, ranked as its worst since August 2011. That speaks to the brutal day tech stocks had. The Nasdaq Composite's 4.1% fall was its biggest since the U.K.'s Brexit vote in June 2016, and the second-biggest of the past five years.
Very Good News From the Collection of Indices
The latest data from the collection of indices we put together for two manufacturing groups are about as good as we have seen in years. These are collected for the Chemical Coaters Association International and the Industrial Heating Equipment Association. Both are heavily involved in manufacturing—one group is the metal-coating bunch and the other is the heat-treating crowd.
There are two ways one could look at the current month's data. There would be the "glass half-empty" approach that would assert this is the peak of the economy's performance. From here, things will start to look worse. Then there is the "glass half-full" approach that would assert this is only the beginning of a nice long run of good economic news. It is hard to say which of these is most likely to play out, but what can be said is the index readings have not been this good in a long time. Of the 11 categories, there are nine that are trending positive. Only two are trending in a negative direction. Of the two that are down, one of them is still really good and presents nothing to get worried about.
Those who warn this may be the peak will highlight some factors that will be fading from this point. The impact of the tax cuts has been felt by this time and will play a reduced role for business the rest of the year. The trade wars and tariff threats prompted a lot of companies to aggressively buy, sell and ship before these restrictions came into being, but now they are in place, this activity will come to an abrupt halt. Regardless of how the elections go, there will be many bitterly disappointed people. The investment community will need time to adjust. That will likely shake the economy for a few weeks and maybe longer.
Analysis: The nine categories that ended up in positive territory include new automobile/light truck sales. This reflects the fact that consumers are still quite confident about their job security and have no issue with taking on debt to buy a new car or truck. The new home sales category is healthy, although it is important to note there is a deepening division between the cities seeing growth between 20% and 40% and those that are shrinking. It has all come down to which cities are generating jobs. The existing home market has not been quite as lively as the new home sector; it is much the larger of the two. The steel consumption category is still reflecting the desire on the part of steel consumers to hoard cheaper steel, but there has also been evidence of returning steel demand in everything from vehicles to pipelines to construction activity. The metal prices readings are all going up, which has been anticipated for some time. The only one that hasn't is gold. That would suggest fewer people are seeking shelter from inflation in this metal. The other industrial metals are all going up in response to increased demand.
The reading for capacity utilization has inched closer yet to the level considered normal. The manufacturers did a lot of machine purchasing earlier in the year. They now seem to have gotten these machines to the point of productivity. The rate of capital expenditures often mirrors the capacity numbers—this month is no exception. There were some artificial boosts to both of these categories earlier in the year due to the tax cuts and the tax changes, but these have now faded to some degree and the motivation for cap-ex is now more traditional and sustainable. Both factory orders and durable goods orders are up nicely. The energy sector and aerospace have been important to the durable goods category while factory orders are responding to additional retail demand as there is an expectation of a good holiday spending season. There was a nice gain as far as the Credit Managers' Index was concerned. This came on top of a gain last month—qualifying as a trend of sorts!
The only two categories that declined were Purchasing Managers' Index (PMI) new orders and the Transportation Activity Index, but neither of these would seem to signal any kind of crisis. The PMI data is still above 60, extremely good positioning. It is considered growth oriented if it is above 50, so 60 is very solid growth indeed. The transportation data fell just slightly, but this is likely to be seasonal more than indicative of deeper issues. Rail is in the middle of its fall slump in coal shipments, but when cold weather sets up, the demand by utilities will be back up. Ocean cargo is down for the season as well, but resumes next spring.
New Automobile/Light Truck Sales
The sales of new vehicles seem to have reached a point of some stability. There are even some indications of a revival. This continues to baffle analysts to some extent as there has been an expectation of declining sales for some time. It has been assumed that sooner or later there would be enough resistance in the consumer sector to slow the pace of sales. But these problems have not really manifested. Consumers are still upbeat as far as employment is concerned. That is often the crucial factor as far as buying a car. It is not that consumers ever lose interest in buying a new car—that is the one purchase nearly everybody will choose to make if they think they are able. The question is whether they have the ability to engage in a purchase that will take years to make. Confidence in the future and job stability is critical. Right now, confidence levels are very high. Most people feel very good about the security of their employment. Thus, they are continuing to buy. There may also be some who are starting to anticipate higher inflation down the road and want to buy now while prices may be lower.
New Home Starts
The news from the housing sector has been decidedly mixed of late, not all that unusual. The good overall news is that after a pronounced slump there has been a big recovery—not quite back to where it was earlier, but back to respectability. The news from the existing home market is still a little down. That is the much larger part of the housing data. More important to those companies selling into the housing market is the wide divergence between the growing markets and those that are not. The latest data from the Case-Shiller index shows that the top-10 housing markets are growing between 20% and 50%, while the bottom-10 markets are actually starting to shrink. It is no coincidence those cities that have seen the best job growth have been the ones seeing housing growth numbers surge—all of those in the top 10 have severe housing shortage issues and severe labor availability issues.
The level of steel consumption continues to rise despite all those dire warnings regarding the elevating price of steel. There are at least three factors that seem to be contributing to this. The first is there is still some evidence companies are trying to beat the tariff-induced price hikes. Overall, the price of steel has risen by around 40%, but not all the global steel producers have jumped on this bandwagon with the same enthusiasm. There are still those going for market share and have kept their prices a little lower—at least for the time being. The second factor is some grades of steel are getting exemptions from the tariff. If consumers of that steel can prove it is not produced at all in the U.S. and they must buy it from overseas, there is a possibility of a waiver on that tariff. Companies are trying to get as much of that steel as they can before the waiver is denied. The third motivation is just increased demand from sectors like automotive and construction. The two-biggest demand sectors for steel are both a little healthier now than they have been in the very recent past.
Industrial Capacity Utilization
The rate of capacity utilization is headed back in the preferred direction. It is still a bit short of what has been seen as normal or ideal (between 80% and 85%), but in many industrial categories, the rate of utilization has been in that normal range for several months now. In some areas, the percentage of use has exceeded 85%, but there are concerns regarding shortages. This has been true in the energy sector which has come back to life with the rising per barrel price of crude. There has also been a capacity issue showing up in some manufacturing sectors related to health care. The good news is that much of the manufacturing community made equipment purchases at the start of the year—reacting to the tax cuts. For a few months, that capacity was not in full use as companies needed to train workers and get the new machines integrated, but that seems to have taken place. Now, the equipment is working closer to expected capacity.
It took a little longer than had been expected, but the price of metals started to rise this last month or two. The expectation had been that pricing for all the industrial metals would rise along with the price of steel even though most of them were not subject to the tariffs imposed on steel and aluminum. That is finally taking place and there have been some sharp hikes as can be seen with the aluminum data. Copper surged right along with the other two and then eased off a little. The price of gold has leveled off as well although that has little to do with industrial demand. Gold is the traditional hedge against higher inflation. The prices had been going up as inflation worries continued to build. Now there seems less concern inflation will surge in the near future and the buyers are relaxing a little.
PMI New Orders
The response of the PMI data was a bit unexpected—at both the new orders level and for the overall index. Given all the industrial growth of late, it would have been expected these numbers would also be growing, but instead there is a bit of a stall. This is not really a big concern, however. The numbers for the new orders data remain well above the 60 mark, still very solid growth territory. As long as the index stays above 50, it signals expansion, which has been the case now for more than two years. The new orders data has been above 60 for that same period of time. This continues to bode well for the future. When there is growth in the new orders category, it means there are orders for all manner of machinery and inventory. This has been seen in everything from commercial aircraft to rail equipment in the transportation sector. There has been growth in the medical equipment sector as well as consumer appliances. In fact, the only area that has not seen a lot of growth has been in the agricultural sector. The fastest-growing sector has been energy.
The rate of capital expenditure has been rising again. That is a good signal given the tax cut impetus has faded a little. At the start of the year, one could look at all the investment activity connected to the tax breaks and the expiration of some of the old tax incentives. It is forgotten by many that along with the reduction of corporate taxes came the elimination of many tax incentives and loopholes. Many companies rushed to get their purchasing done before the tax breaks expired. Now, the majority of them have. This means the expansion taking place now is more genuine and connected to perceived demand. The fact that capacity numbers are edging closer and closer to normal is another good sign as these two measures tend to mirror one another (at least in most months).
Durable Good Shipments
The trajectory for durable goods orders has been solid of late helped along by growth in three or four major sectors. The fastest-growing demand has been coming from the energy sector with significant interest in expansion as the per barrel price of crude has risen and may rise as high as $100 a barrel in the not very distant future. It was only a few months ago that many analysts confidently asserted there was no way it would get back to that level. The second area of growth has been transportation as there has been a renewed demand for aircraft and for other transportation-related product. Rail cars are in demand and so are the engines. There has even been an increase in demand for trucks and cargo ships. The third area of expansion has been health care-related. This includes everything from medical devices to the equipment used in hospital maintenance—food service, laundry and the like.
The factory orders numbers look very good. That is encouraging given the experiences of the last few years. Normally, one would expect factory growth this time of year as it is the time consumers are expected to be most active. The rush to prepare for the holiday season was supposed to serve as stimulus, but the last few years have been disappointing as the retailers have approached the season with some trepidation and suspicion. They have gone into the holiday period with an "inventory light" strategy. They limit the size of their inventory and focus on capturing as many of the early shoppers as possible while essentially leaving the late comers to reduced options and choice. This year, there are still plans to break out the sales and discounts early, but there is likely more inventory in play for the whole season. That has meant more demand for factory output.
Blasts From the Past
It seems at certain ages there is a desire to revisit old haunts or connect with people long part of a dim history. I have had a few of these experiences and so have other friends who have discussed these encounters with me. The problem is our memories have remained static and the things and people we knew have not. We know this on an intellectual level, but seem unprepared on a more emotional level. The idyllic little spot from 20 or 30 years ago is now a parking lot. The lovely café we frequented when we thought we would be the next Hemingway is now a Starbucks full of erstwhile consultants.
Perhaps nothing is more shocking than how much people change. And sometimes the astonishing part is they haven't changed all that much. I have had conversations with at least three women who were contacted by old boyfriends who believed all three of these women had been pining away in hopes their high school sweetheart would call once more. The reactions ranged from pure horror to hysterical laughter. These women went on to great heights as an accountant, lawyer and engineer. The former heartthrobs never rose past their high school peak. It amazes me what manages to linger in one's mind for decades.
I have re-connected with some childhood friends of late as well and the amazing part for me has been that we barely missed a beat—it was if we had been hanging out all along. Either they changed right along with me or I am no different today than when I was about eight. I suspect the latter to be true.