Business Intelligence Brief: July 14, 2017
Short Items of Interest – US Economy
- Retail Numbers Fall Again – This has been baffling the economists and analysts since the start of the year. When asked in various confidence surveys, the consumer has been asserting that they have great confidence in the economy – now and in the future. Unfortunately, that purported confidence is not carrying through into any kind of retail surge. The latest numbers show another drop in retail sales – 0.2% and that comes on top of a decline the month before of 0.1%. This is not the trend one would expect from a supposedly confident consumer. It seems that the responses to the survey are wishful thinking and that the reality is that people are still cautious about spending their money.
- Inflation Likely to Head Back Up? – This has been the assertion of the Fed Chairman in comments before Congress. Yellen asserts that at some point the tight labor market will prompt higher wages and therefore wage inflation. She also notes that imports have become more expensive as the dollar was weakened a bit and this will also contribute to more inflation and sooner than later. This commentary supports her position that rates will continue to rise this year and very likely into next. The low levels of inflation that have been noted thus far this year have given the Fed a reason to pause and may mitigate against a hike in September as had been expected but the belief is that rates will rise by December at the latest.
- Industrial Output Bolstered by Gas and Oil – Tracking the changes in industrial output can be a challenge as the three components of the data are different and respond to radically different motivations. It consists of manufacturing, utilities and mining. The latter category includes gas and oil development and this is the sector that drove the gains in industrial production this time. In past months, the driver had been manufacturing but that slowed down and the utilities have still not seen the summer heat needed to really drive their activity (although it is coming and started to make a big difference in July). The gas and oil concerns took advantage of the OPEC reduction and US companies quickly moved to fill the void.
Short Items of Interest – Global Economy
- A Chinese Reminder – In many ways China has changed and evolved and has played a major role in the global economy but it remains an autocracy and one that exerts tight control over its population. The most famous of Chinese dissidents died of liver cancer and China is busy scrubbing all mention of Liu Xiaobo from social media and the press in general. The winner of the 2010 Nobel Prize has spent the better part of his adult life in prison for his engagement in the Tiananmen protests and others. To the Chinese government he is a subversive and to the rest of the world he has been a democracy activist and human rights advocate. China is doing its best to erase every trace of him but that has proven very difficult.
- Temer Dodges One Bullet – The President of Brazil is fighting a whole host of corruption charges but the first attempt to bring him down has failed as the constitution and justice commission in the lower house of the legislature has voted against bringing the charges forward. It has been asserted all along that Temer would be able to fend off much of this attack as nobody has more of an idea where the bodies are buried than does he. Those who attack him are likely to be exposed and attacked in turn. He may well be able to hold off his critics indefinitely.
- Britain Faces Brexit Reality – When the UK elected to depart from the EU the assertion of the Europeans was that they would have to pay to leave as was demanded in the charter. The British leaders asserted that they would do no such thing but now it has been acknowledged for the first time that they will indeed be required to pay and the bill will not be a small one. It is enough to bust the current budget and will have an impact all over the country.
What Worries the Forecasters?
The economist is supposed to be a soothsayer to some degree. Not that people are uninterested in knowing what has happened in the past and why but the real question they want answered is what is going to happen and sometimes the requests can be pretty unrealistic as far as timing – what will the economy look like in five or ten years. That would be akin to asking our brethren, the meteorologist, what the weather forecast will be five to ten years hence. The best that can be done will be vague generalities (hot in the summer and cold in the winter). The forecast challenge is made more complicated when there are lots of dependent variables as there have been this year.
Analysis: The forecasts for this year were very optimistic at the start but they were also loaded with caveats. The starting point for these estimates was the 2016 economic performance and it had been trending in a pretty positive direction. There had been steady job growth all year with the unemployment rate moving down from 5.1% at the start of the year. The growth of the overall GDP was trending up slightly and Q3 of 2016 was the strongest growth notched in over three years. The forecasters observed an increase in business and consumer confidence throughout the year and it was hardly dented by the campaign. The inflation pace was slow and most of the other indicators had been trending in a very positive direction with both the Purchasing Managers’ Index and the Credit Managers’ Index – well above 50 and in solid expansion territory. The forecasts for 2017 were good simply because there was confidence that these were real trends and at the very least they would continue.
As the Trump administration got underway there was another jolt of confidence based on the assumption there would be major changes taking place. This was connected to the campaign promises but that was only part of the story. The real motivation for this enthusiasm was the fact the GOP had won control of government with their success in the Senate and House. It was assumed that this would provide unity and an opportunity for the GOP to follow through on its platform. It has not worked out this way as the Republicans are not all that unified. The assumption at the start of the year was that there would be a repeal of the ACA, major tax reform and tax cuts, extensive deregulation, new trade policies and massive commitments to infrastructure spending. None of this has come to pass and the supposed unity of the GOP has been exposed as a myth (and Democrats are no more organized). The first one hundred days of the administration were essentially wasted as the Trump White House quickly became bogged down in controversy and fell on the defensive. The energy that might have been applied to these economic promises was spent on issues related to the campaign (such as Russia) and explaining various missteps and bizarre interactions.
Now that the 100 days are over and the year is at the midpoint, the assessments are being revised with the assumption these changes will not take place. The new health care plan has proven very hard to develop and without it there is little room for the tax cuts that have been suggested. There has been very slow progress on deregulation and trade policy has been haphazard and ineffective. The sense is that there is almost no strategy and no coherent plan to unite the disparate elements of the Republican party. There is also no hope at all of bipartisan activity and that imposes very strict limits as to effectiveness.
There is another factor that will start to play a bigger and bigger role. The elections of 2018 are right around the corner – at least as far as politics is concerned. Those who are up for election in a year have started their campaigns already and are now far more sensitive to the mood of their constituents. This is a two phase process as these politicians will have to first satisfy their core supporters in order to get through the primaries and that tends to make them unwilling to compromise on much of anything. Then they will have to focus on winning support from the general population in the final election. If Trump’s popularity numbers keep slumping the Democrats will run against his administration and will turn the mid-terms into a kind of referendum. Traditionally the President and his party lose ground in the mid-term election and this may be a more serious decline than usual. In this atmosphere, it gets even harder to pass complex legislation.
The good news is that the economy doesn’t react just to the politics of the day. The forces that started the recovery in 2016 are still in place and will continue to make an impact in 2017 and beyond. Consumers are slowly coming out of their funk, exports have been improving, jobless numbers are still low and there is still little in the way of inflation. The fact is we all go about our business regardless of what is going on in government and that propels the economy.
Why Yellen Will be Replaced and Why She Will Not
The future of Janet Yellen as Chair of the Federal Reserve is under discussion but there is nearly a year between now and when she would be facing a second term or retirement. Trump has not been remotely clear about what he thinks of Yellen and the Fed as he has both praised and condemned the policies of the last few years. Right now, economists give her a one in five chance of being retained.
Analysis: The reason she would be replaced would be for Trump to put his own choice in that position but nobody really knows what he wants the Fed to do and there is no clear favorite to replace Yellen. The reason she would be given a second term is that the markets crave stability and predictability and she has been good at delivering that. The next big issue is inflation and few want to be trying to figure out a new Fed chair at the same time they are worrying about inflation for the first time in over ten years.
The Steel Issue
In many respects, the issue of steel has become a symbol of the overall challenge of setting and altering trade policy. The campaign promise was relatively simple and straightforward and initially gathered a lot of support. The assertion was that the US steel industry was in bad shape (demonstrably true) and that something needed to be done about this. The role of steel in a national economy has long been outsized. Steel production is seen as vital to the growth of the economy and important to the notions of national security. Remember that the original name of the European Union was the European Coal and Steel Community as the notion was that nations could not wage war with another if their steel industry was monitored and controlled. The US steel sector started to suffer decades ago as competition built in other nations and the US steel maker struggled with issues ranging from labor relations to the scarcity of scrap. The US imports a great deal of steel now and some of it come from nations that either subsidize their steel production or find ways to sell their steel at a discount.
Analysis: The “solution” has been to impose tariffs on imported steel and to do so under the rubric of national security. The nation that draws the majority of the US ire is China despite the fact that Chinese steel is only around 6% (on average) of the total imported. The Chinese scare the US as they are aggressive in their subsidies and seem prepared to dump a lot of that cheap steel on the US. They used to consume the vast majority of the steel they produced but with the slowdown in their economy they need to find some place to send it. The fact is that most of the imported steel coming into the US comes from Canada, Brazil, South Korea, Turkey, Mexico and Japan (in that order). The first three nations alone account for 45% of the imports per year on average and all three of these states are allies of the US. It has become obvious that whatever tariffs are imposed there will be exemptions (Canada has already received one).
The bigger issue is what protecting the steel industry will mean to the rest of the economy. The users of steel fear that strict tariffs and quotas will drive prices very high. The steel sector has been weak for a long time and needs an opportunity to catch up. They will likely take full advantage of the import limits to boost their revenues and profits. The steel users will have a limited number of options. They can accept the higher prices and try to pass that cost on to the consumer but they then run the risk of losing business to overseas competition as these companies will not be paying the higher prices for steel. This is the prime concern of companies that use steel to produce vehicles, construction equipment, farm equipment and the like. Much of the steel consumed in the US is slated for construction use and the bulk of that is public sector. The infrastructure plan that has been bandied around calls for an investment of a trillion dollars and if the price of steel shoots up the projects will cost twice as much. That either means getting only half the projects now planned or trying to double the investment to two trillion.
The steel sector needed to be saved twenty years ago. What was needed was better access to scrap steel as that is the resource the US depends on now. The supply has been shrinking for years as there is less steel scrap coming from cars and trucks and from construction tear-downs. The most lucrative scrap source is ships but very few are scrapped in the US due to environmental concerns and that leads to the US selling its decommissioned warships to China to scrap. There is a good reason to try to bolster the success of the US steel sector but doing so at the expense of the steel user is not a very good economic strategy.
Diplomatic Test for Russia and US
At the end of the Obama administration the US ordered two Russian compounds to close and access was denied to several other sites. The assertion was that these facilities were being used to spy on the US and the decision meant that 35 Russian diplomats were expelled and returned to Russia. There was distress in Moscow at the time and vague threats of retaliation but by then Trump had won the election and Russia elected to wait and see what would happen. That patience has apparently worn thin as Russia is now threatening to close US operations in parts of Russia as a response to the December actions by the US.
Analysis: If one steps away from all the internal angst over Trump’s interaction with Russia and looks at what Putin wanted to accomplish it is clear that Russia hoped for a new attitude from the US. They wanted sanctions lifted, they wanted their diplomats back in the US, support for their position on Syria, support in their contests with Europe and so on. Perhaps Trump promised a new relationship would emerge and perhaps he didn’t. The reality is that there is little room to cooperate with Russia now and they are not likely to get what they had hoped for. The chill in diplomatic relations is alive and well.
The Black Owl Report – An Executive Intelligence Brief
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It’s the Local Economy, Stupid
I had an opportunity to speak to a luncheon sponsored by the Independence EDC. The economic development people in a given community are really the unsung heroes of the local business community and the keys to whether there will be economic progress. I often try to point out that national numbers on growth or employment or anything else are of limited value as they are the average of 50 states and an economy of almost $18 trillion. I have pointed out that every state in the US has a GDP that corresponds to that of a country – California is the size of France and Texas the size of Canada. The meaningful numbers are local.
The economic development teams across the country have similar mandates but they differ in terms of how they go about developing the economy of their community. The Independence group focuses on the existing business community as opposed to spending all its time trying to recruit companies to relocate (although they do that too). The focus has been on helping the small and medium sized business reach their goals and that is crucial. The company could be a tiny little shop with only a few employees or it can be a bigger operation with hundreds and revenues in the tens of millions. The need is nearly identical – people willing to work and consumers willing to spend. To get the US economy as a whole to grow by 3% or 4% means growing these local economies.
These are parts of the commentary that appeared in a recent Black Owl Report. We invite you to start a one month trial subscription so that you can see the variety we offer in this publication.
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Our Take on the Lidl Story – We were watching our normal barrage of news reports today, and noticed that CNBC was doing a bit piece on Lidl. For those of you that don’t know about Lidl, it’s a German grocery chain that prides itself on providing the cheapest prices on groceries, with the highest quality private-label products available. They don’t have a wide selection of products, but they probably have what you need and it will be of fairly high quality – in private label products.
They accurately point out that the American consumer will have to get used to private label products being a “quality product”. We typically view those products in the US as being sub-par. Lidl wants to change that perspective.
What I want to focus on for a minute is the whole concept. Lidl is using a minimalist and efficient operating strategy to help drive costs as low as possible. The stores are no-frills in some facets – but interesting and innovative in areas where it counts. Advanced automation and use of Big Data is rampant throughout the company, from warehouse management systems to merchandising, POS systems, and sales/marketing digitalization.
But, by squeezing every penny out of their operating model, they can compete on a low-cost basis against the behemoths in the grocery world – and win at a point-of-sale level. Product prices are at parity, or cheaper than major retailers. They don’t carry as many SKU’s as a full-line grocery store, but they have built their strategy on having everything that the average consumer needs on a weekly basis. They’ll let the large format and specialty grocery stores win on items that are occasional or infrequent purchases. There’s a lot more to the Lidl story, but that’s not the point.
My point in bringing up Lidl is that it is a disruptor. It’s a disruptor hedging on some old school strategies to be a low-cost leader – coupled with the best new technology to enable it to compete profitably on a low-cost basis.
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