Actions+Reactions+Overreactions=Corrections [eventually]
As Warren Buffett stated recently, we are in a “red hot” economy. In April 2020, the Cares Act pumped $2.2tn into the economy to help all the people and businesses that were hurt by COVID-19 shutdowns. Another $900bn followed in December plus over $2tn this year. Now there is a $4tn infrastructure stimulus bill on the table, much of which will be spent over 10 years. No wonder we have a red hot economy. And about $2tn in savings may or may not get spent in the near future.
The economic data is spectacular. GDP was up 6.4pc in Q1 and the expectation is higher for the rest of the year. Consumer spending on durable goods excluding aircraft was up 41.4pc on an annual basis in Q1. Nondefense capital goods excluding transportation, a proxy for business investment, was also strong in March after a slight drop in February.
Other leading indicators on new orders and production are still high even after dropping a little due to supply chain issues. As more of us get vaccinated and feel safer going out, more money will be spent on entertainment and travel and somewhat less on consumer durables.
The main problem for manufacturing is the supply chain. Tim Fiore, chairman of the ISM Manufacturing Business Survey Committee, summed it up: “Extended lead times, wide-scale shortages of critical basic materials, rising commodities prices and difficulties in transporting products are affecting all segments of the manufacturing economy.” Labor shortages are also a major concern. Health concerns, expanded jobless benefits, fear of the virus, and being needed at home are keeping people out of work.
Just-in-time (JIT) was the manufacturing mantra for decades, but now it doesn’t look like a smart process to follow. Many parts essential to manufacturing other products are being affected by short supplies. Semiconductor chips is just one example. Automotive production will be down by over a million vehicles this year due to just that, and there will be fewer electronic gadgets on cars produced this year. Increasing essential part inventories to a comfortable level will take time and investment.
An overreaction of rushing to create more inventory can cause problems in a downturn when that three-week inventory turns into six weeks or more, and orders for these essential items drop. Take the case of toilet paper [sorry about the pun]. Last year, when everyone was buying all the TP they could, there was a temporary shortage. Now, many consumers are working through a six-month or more stockpile of this item. Correction happens.
Housing and construction is another sector rebounding strongly. It is a much longer cycle and can’t be turned on with a switch. The bust that took place after the 2008 bubble is causing a shortage now. There is little land to build on and fewer skilled construction workers. One of the top building and construction forecasters, Todd Tamalak, spoke at the Aluminum Association virtual meeting last month. He expects aluminum demand in the building and construction sector to be up 10pc year-over-year and new houses and resale house prices to be up over 12pc this year.
He also noted that banks and hedge funds are buying up good houses in good markets, fixing them up, renting them, and planning to hold them for 50 years.
Economists used to teach that too many dollars chasing too few goods caused prices to go up. The Fed continues to forecast good growth through 2023, while maintaining that the Personal Consumption Expenditure Index they use to track core inflation will even out at a little over 2pc once things settle down. US 10-year treasury bills, which indicate what the market is forecasting, remain fairly calm at under 1.7pc.
European manufacturing is picking up despite COVID-19 related shutdowns. China’s PMI and Caixin are positive but not as strong as what is taking place in the US. The Shapiro Nonferrous Scrap Activity Index for April was even with March. This reflects the goods shortages in the supply chain and the shortage of workers.
There is no shortage in hedge fund and speculator demand for commodities. They are spiking to record highs. Copper is at a record and now approaching $5/lb, up 35pc from January 1. Aluminum is also reaching new highs and is up over 30pc from January 1. The Midwest Premium for aluminum is currently 26 cents, up from 11 cents five months ago.
There is still lots of talk about Section 232 and whether this will change and reduce the premium. Expectations point to something occurring later this year. Prices for steel, nickel, and zinc are also getting close to highs or setting records. You could call this a commodity super-cycle or a “melt-up.”
Fundamentals for physical demand have not substantially changed. Demand is very strong but not so strong to cause the prices to run this high. Consumers did not plan right and are short on metal with the increased demand from manufacturers. Scrap is also in tight supply.
Prime aluminum scrap prices spiked 10 cents this month. Secondary aluminum paused this month for the first time since June last year, with aero chips the same but almost triple the price. This is due to the auto slowdown. Scrap copper is up 16pc and prime nickel is up 9pc. Prime iron ore also soared while scrap steel came in the same as last month. Stainless steel was off a little.
I remain optimistic about the economy despite questions that are circling. Is this a commodity super-cycle? How long will it last? I am sure of two things: The trend is your friend, and correction happens.
“The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.”
-William Arthur Ward
Life is good. Family and health are precious. We have lots to be grateful for.
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 by the author are subject to change without notice.