THE ECONOMY:
Construction spending hits a record high.
The 0.5% gain topped expectations (0.3%) at $1.05 trillion. That is a solid indication that CEO's are putting their confidence in the economy into practice. Of course, construction spending has made a series of records since February 2004, so this was no earth shaking news. Private construction rose 0.5% while private residential construction rose 0.3%, both hitting new record highs.
The key was private nonresidential building, rising 1.1% after falling 1.4% in February. That is the sharpest gain since October 2004. It does not bring construction spending out of the woods into a new sprint higher, but it does show that after a really harsh February weather-wise, many projects got the go ahead. In the big picture capital spending is still quite solid even as the housing market continues to flatten.
National ISM weakens but continues to expand.
In a soft patch things slow down. In April manufacturing sentiment slowed to 53.3, below expectations (55.0) and at a 2 year low. New orders fell to 53.7 from 57.1. Employment dropped slightly to 52.3 from 53.3. Yes things slowed and it was a 2 year low, but still the twenty-third straight month of expansion, the longest expansion in the sector since a 3 year run that ended in April 1989. Impressive.
What is more impressive? One of the big worries in the Q3 GDP report released last week was the inventory build that indicated slowing sales and thus lower future production runs. That can snowball and result in an even faster slowdown. Well, before the GDP report even cooled off the April ISM already showed inventories declining. At 47.9, down from 54.1 in March, inventories showed the largest decline of any component. March was the biggest slowdown month of Q1, but already in April companies were turning inventories around. The new inventory management systems are pretty amazing. Just 10 years ago it would take another quarter at a minimum to make significant inventory adjustments, and now a month hence they are already well on the way to reaching adjustment levels. As a kicker, prices paid fell to 71.0 from 73.0. Not a windfall decline, but another step in the right direction after running near 80 in Q1.
The most impressive reading: 53.3 corresponds to a 3.8% GDP growth rate. Thus even in a 'slow patch' the economy is still producing a very nice growth rate. I discussed this past weekend about how the economy was being maligned as a result of recently softening data. We saw this slowdown earlier in the year, and it is no surprise given the Fed raising rates and oil prices above $50/bbl. This is not a major slowdown in the economy, however, as it stands. The real concern is what the Fed does and whether it pulls a repeat of prior campaigns where it hiked us right out of prosperity and into an economic slowdown or even recession.
At this juncture it is not baked into the cake though the oven is hot and the pan is warming up. The yield curve continues to flatten as the Fed raises the short end but the long end continues to rally (long rates fall). Right now the Fed Funds Futures contract is pricing in three more 25 basis point hikes (putting the Fed funds rate at 3.5) with an additional 25BP hike after that as a wildcard. Greenspan still has a conundrum to figure out, but frankly, no economy or market feels comfortable with oil at $50/bbl and the Fed raising rates. Thus the 'conundrum' is really more of a historical understanding of what bothers the market. You can have all of the strong economic data you can muster and those two items will make any market take pause. That is exactly what this market and economy have been doing, though the market is worried about further down the road than the recent batch of economic data as the market is more a predictor of economic growth than a reactionary to it.
Thus the issue is not so much of a current serious economic slowdown, but what the Fed's role is in shaping the economy down the road with rate hikes even as gasoline is set to rise to $3/gallon on average this summer. You can desire some extra maneuvering room in the form of a higher Fed Funds rate so you can cut rates in the future if you have to, but using interest rates to fine tune the economy is similar to the Forest Service using controlled burns to limit future fires. As we saw last year in New Mexico, a fire can get out of hand and burn down a lot more than intended, particularly when there is an ongoing drought. With a weaker economy and rising gasoline prices, raising interest rates in order to have more maneuvering room in the future seems to be, well, playing with fire. Problem is, it is us, not the Fed, that gets burned.
EU manufacturing contracts.
The US takes a lot of heat abroad and here at home for its trade gap. The US consumes much of what it produces and a lot of overseas goods as well. When it is healthy, as it has been for much of the past 25 years, we consume a lot more. That raises the sniping about how our economy is out of balance, how a 'day of reckoning' will come, how we all must be some kind of bad actors because we like to enjoy our prosperity and consume goods.
As I have discussed before, however, one of the very factors that makes us so out of balance is that most of our trading partners outside of China and India don't have strong enough economic engines to consume any of their goods. Indeed they have built their economies the past twenty years on feeding the US consumption engine. With those circumstances it is easy to build up a big trade imbalance.
A case in point continues to be Europe and its union. A week ago Germany announced its GDP was going to miss expectations of already puny growth. Monday the EU announced its equivalent to the ISM was less than 50, meaning that the EU manufacturing sector was shrinking. No wonder with high unemployment and regulations on just about everything you can think of and then a few more just for good measure. I reported before that after the EU formed and global regulations were written to supplant local regulations, instead of declining due to streamlining and cutting duplication, the number of regulations actually rose. A bureaucrat's dream no doubt.
The EU is just one example of strangled economies that are lagging in economic production, exacerbating a trade gap. That continues the argument that they will dump US assets at some point because the US becomes some kind of bad risk investment, but when you think about it, does common sense really bear this out? First, they want the US to buy from them as their economies depend upon it. Thus they are not about to do anything that would undermine our consumption of their goods. Second, with their economies and most others in the world in the toilet, stagnant, or heading the wrong direction (e.g., Russia and its move away from the rule of law other than the law of the KGB), are they really inclined to exit the economy with the system that continually churns out innovation and growth? Yes China will get investment dollars as will India, but the US is not going to be shunned. The grass is always greener, and in this case when compared to their own economies and most others in the world, it truly is. |
