Three years of lockdowns forced the Chinese to be literally prisoners in their own homes. The only time they could go out was with special permission, and you had to be tested every few days. Most people were out of work. If you bought a new home, you had to prepay for it, and then it couldn’t be built and delivered because of the bankrupt building industry. Housing prices keep dropping. Zero-Covid ended in December 2022 without much planning, and many people got COVID and died. This is Post Covid Stress Disorder (PCSD). This anxiety and fear will not change for years.
The Chinese Communist Party Politburo meeting was held at the end of July. “China’s economy is facing new difficulties and challenges, which mainly arise from insufficient domestic demand, difficulties in the operation of some enterprises, risks and hidden dangers in key areas, as well as a grim and complex external environment.”
They acknowledged the property market issues of high inventories, falling demand and prices. Local government debt is a serious problem, and consumer spending is off considerably. After the end of COVID-19 in December 2022, GDP grew by 4.5pc in Q1. It then fell off in Q2 to 0.8pc.
That was the good news. The bad news is there were no solutions offered. Yikes! VUCA is my favourite acronym- volatility, uncertainty, complexity and ambiguity and certainly applies here (I went a whole month without using it). At some point, the government will try to implement monetary “fixes”. It is the PCSD that they won’t be able to fix for a long time.
The July official manufacturing PMI rose slightly and is still in contraction, while the services gauge fell almost two points to 51.5, much lower than expected. The Caixin Private Companies’ Manufacturing Index dropped from 50.9 to a six-month low of 49.2 last month, with a contraction in the sector as export demand slumped. A separate report showed home sales tumbled 33.1pc in July, the most in a year.
How does this affect the US and the rest of the world? The property bubble in China is mainly financed with Chinese debt and with very little foreign debt. It won’t spill over into the US. The same is true for the local government debt. U.S. goods exports to China were $154bn, which is about 0.6pc of the U.S. GDP. Exports to Mexico were more than twice that. Other Asian countries are more dependent on China and will suffer more.
Still, economists are forecasting the Chinese economy will grow slightly over 5pc. That might be difficult with how quickly their economy is falling. The good news is that the Chinese slowdown will reduce demand for the commodities they need and reduce worldwide inflation. The bad news is worldwide growth will be slower.
Soft landing now, recession later?
Looking at every recession since December 1969, the economist David Rosenberg (not Omni’s David Rosenblum) has calculated that, on average, the Leading Indicators Index starts to decline 13 months before a recession begins and falls 4.6pc before the recession begins.
– Leading Indicators are now down 15 months in a row.
- – Lead Indicators started falling 18 months ago and are down 9.9pc.
- – Inverted yield curves have predicted every recession except one in the last 50 years. The yield curve has been inverted (it is a long explanation I won’t go into) for 16 months, while most last only 10 months.
- – Retail sales keep falling.
- – China and the rest of the world’s economies are slowing.
The soft landing means economic growth, falling inflation, and strong employment. The Fed staff now forecasts no recession this year. Interest rates are near the top and should start dropping next year. Consumer balance sheets and confidence remain strong.
Real GDP grew at a 2.4pc annual rate in Q2, beating consensus expectations. The growth in Q2 was led by consumer spending and business fixed investment, with all three major categories of business investment higher: equipment, commercial construction, and intellectual property such as research and development. Government purchases also accounted for GDP growth, while home building and net exports suffered small declines. Core GDP increased at a 2.3pc annual rate in Q2, very close to the growth rate for overall Real GDP. Even though Leading Indicators signal a recession, Coincidental Indicators remain positive and in growth mode.
There are several reasons why the US should outperform the world for many years. Onshoring and reshoring are happening fast. Much of Biden’s measurably stimulative post-COVID legislation was actually passed by Congress and is great for the economy.
- – The Infrastructure Investment and Jobs Act of 2021 authorized $1trn of government investment over 10 years.
- – The Chips and Science Act 2022 authorized $278bn for energy projects, including highly stimulative tax credits.
- – The misnamed Inflation Reduction Act provides $499bn in tax credits and other subsidies for manufacturing, including clean energy.
- – The Energy Department’s heavily subsidized loan guarantees are spurring big increases in private business investment.
I look at this data and believe we are headed for a soft landing and a bright future until the next black swan pops up.
Inflation
Inflation continues to look better. Fed interest pauses are more likely for the year.
– The Consumer Price Index (CPI) for July rose 0.2pc to 3.2pc from a year earlier, a 1pc monthly drop, and is down to 0.2pc for the month. The core CPI, excluding food and energy, eased 0.1pc annually to 4.7pc. The monthly figures, however, offered a more encouraging picture of current price trends. Even better, the core CPI increased just 0.2pc in both months, suggesting inflation isn’t starting to resurge.
The new numbers lowered the three-month annualized core inflation rate to 3.1pc, the lowest reading in two years, from 5pc in May. “My God, that’s incredible,” said former Fed governor Laurence Meyer. “There’s absolutely no question that core inflation has turned the corner faster” than the Fed anticipated.
– Super Core inflation is the Fed’s preferred inflation measure. It is part of the Personal Consumption Expenditures (PCE) for services, excluding food, energy, and housing. Super Core prices are down to 4.1pc versus a year ago and the lowest since mid-2022. It was up 0.2pc on a monthly basis, the same as the previous month. “Core” inflation, which excludes only food and energy, is up 4.1pc on a year-ago comparison basis and down 0.5pc from last month. This data reduces the need for more interest rate hikes.
– The Producer Price Index increased slightly in July at 0.3pc for the first time in three months. The core PPI also rose 0.3pc, with the annual gain falling to 2.4pc. Prices are close to a pre-pandemic level, and more good news on fighting inflation, with the annual gain falling to 2.6pc. Goods inflation abated with lower commodity prices and improving supply chains.
Manufacturing: Continuously mixed results
The ISM, Institute for Supply Management, manufacturing index for July rose slightly to 46.4 from 46 last month and remains in contraction for the ninth month. All the ten indices ISM follows are in contraction. The only positives are that New Orders and Production rose from June, although they are also in contraction. These two lead indicators rose to 47.3 and 48.3, respectively.
It’s not all bad news. US productivity rose the most in three years in the second quarter, helping offset the impact of higher wages. Nonfarm productivity rose 3.7pc annualized in Q2 after a 1.2pc drop in Q1. Labour costs rose 1.6pc after a 3.3pc surge in the prior quarter. The data highlights why firms invest in new technologies, software, and equipment to improve efficiency, as higher productivity can counter the inflationary forces of higher wages and other costs.
Industrial production for June fell 0.5pc and came in weaker than expected, falling for the second month in a row. Factory capacity utilization dropped in June to 78.9 but is still near a 15-year high.
– Shipments of “core” non-defense capital goods ex-aircraft (an essential input for business investment in calculating GDP and a leading manufacturer indicator) were unchanged in June but rose at a 1.9pc annualized rate in the second quarter versus the Q1 average. While still positive, this is the fifth consecutive quarterly deceleration in the pace of growth and represents the weakest quarter since the COVID shutdown-restricted second quarter of 2020.
– Orders for core capital goods (excluding aircraft and transportation), which will lead to shipments in the future, rose a healthy 0.6pc in June. Annually, excluding transportation, it was still up 0.5pc. Including transportation, which our industry certainly loves, annual orders rose 8.9pc.
– New home and existing home sales dropped slightly in July.
– US Nonresidential Construction overall spending is at a new high, helped by a 76pc annual leap in new factories, widely attributed to Inflation Reduction Act.
– New light-vehicle sales in July increased annually for the 11th straight month. July’s annualized sales are 15.74 million units, up 18.3pc from July 2022. GM, Ford, and Stellantis union contracts are up on September 14. I expect a strike to last a while.
– The Shapiro Nonferrous Scrap Activity Index, which tracks our daily purchases from the same accounts across our 10 locations and a diverse industrial base, rose slightly from June and is 3pc below our 12-month trailing average.
Metals: Slow now and bright future ahead
The slowdown in China will continue to pressure the prices of aluminum, copper, and steel. A substantial tonnage of aluminum that China recently imported for domestic consumption is now being exported. There is also a fast-paced restart of a primary smelter in Yunan. China’s decreased consumption and exports and its excessive housing inventory will keep a lid on metals prices for some time.
August metal prices continued their yearlong drift down. Prime and secondary recycled aluminum prices were about the same as in July. The exceptions are copper and nickel, which are up. Steel prices are flat to slightly stronger. The median and mean prices for 2023 dropped by 5pc from Reuters’ June forecast. For 2024 those forecasted prices dropped 6pc.
The aluminum industry sees a bright future. There are three new aluminum mills slated to open in 2025. These will be the first new aluminum mills in over 50 years. Matalco, a Canadian-based billet producer and the largest billet producer in the US, just sold 50pc of the company to Rio Tinto for $700mn. This gives the primary producer, Rio Tinto, a strong, sustainable foothold in the North American market.
Nucor, SDI, and US Steel are among the major mills planning new facilities to increase volumes by 12mn nt of annual growth in the next few years. That is over 10pc growth. They are investing because they expect additional steel consumption from billions of dollars of infrastructure spending on road and bridge repairs, solar and wind-energy facilities, new electric vehicle facilities, and higher automobile production.
Debt crisis redefined
“Afraid of the debt crisis? Try doing the new math,” by Nobel economic prize winner Paul Krugman. I found this interesting and challenging. Many will disagree with this.
My friend Joseph Lehrer points out that Krugman does not mention the substantial risk if the US dollar does not continue its position as the World’s reserve currency. So long as the dollar remains the predominant reserve currency for international transactions, there is a high demand for dollars. That global demand, in turn, allows the United States to borrow money at a lower cost. Thanks to Joe for that insight.
I would feel better if the US started to act more responsibly. We need to look at a strategy that both decreases spending and increases taxes. Unfortunately, that is not how Congress acts. The US keeps increasing spending and decreasing taxes. I know that math can’t work forever.
Here is the link for those that want to read this. READ HERE
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Bruce Shapiro
This report was prepared by Bruce Shapiro and reflects his current opinion of the economy. It is based on sources and data he believes to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice.