Business Intelligence Brief: September 20, 2017

Short Items of Interest – US Economy


  • Housing Market Shifts – Things are about to get weird and it is going to be hard to make definitive statements about the housing sector for a while. The destruction from Irma and Harvey will skew the housing numbers and will have to be factored out. The latest data (pre-hurricane) showed that housing starts are generally down although most of the decline has been in the multi-family sector as single-family homes saw a modest increase. The new home buyer has been rattled to some degree by higher prices and a general shortage of homes but there is still some momentum. The number of new permits issued has increased and that could be a positive sign for the future – assuming some solution to shortages. This may be the toughest to deal with as nearly every person who can build homes has started for Texas and Florida.


  • Consumer Sentiment Fades – The consumer has reacted to the unrelenting reports on Harvey and Irma and now Maria. The news is full of speculation as to how much this disastrous year will cost and the consumer assumes they will be hurt in some way as well. Sentiment has been high all year but this has taken the wind out of their sails for now. It is likely that consumer mood will pick up in the future as the rebuild starts and people understand that the multi-billion-dollar expense of the storms translates into jobs and purchasing replacements for all that was lost.


  • China Continues to Buy Treasuries – For years the Japanese were the biggest buyers of US bonds and they lost that position to the Chinese in June. The Japanese had reclaimed their top spot last October but China has increased its buying for six straight months. The Chinese holdings are still minuscule compared to that which has been held by the Federal Reserve but this means that China still thinks of the US as the safe investment and a place to hedge.


Short Items of Interest – Global Economy


  • UN Speeches – Setting Foreign Policy? – Much has been made of the first speech that Trump has given to the UN and while this is understandable it should be pointed out that UN speeches are rarely anything more than atmospherics. This is the ultimate talking shop and has been the host of many provocative speeches that are aimed more at domestic audiences than to the assembled multitude. Few in attendance have any real interest in the talk as they know that real foreign policy agendas are set elsewhere. The core supporters for Trump are desperately anti-UN and have long considered the institution to be anti-American. They wanted to hear Trump on the attack and he was. The fact is that nothing of substance changed due to these remarks and few expected them to have much impact.


  • OECD Still Expects UK Economy to Struggle Next Year – In the midst of all the confident statements about the British economy shrugging off the impact of Brexit the OECD is throwing cold water on the assertions as it expects the current slowdown in the British economy to extend into next year. The fact is that British exports to Europe are way down and that situation is unlikely to reverse any time soon. The hope in the UK was that more trade with the US, Canada, India and Australia would offset what was lost in Europe but that has not been the case thus far.


  • German Producer Prices Rise Slightly – The level of inflation affecting the producers in Germany was higher than had been expected but it not out of control. The ECB rather likes seeing these rates go up but the Germans are far less sanguine about this. The majority of the rise was attributed to higher energy prices and that was in part due to Harvey’s impact on global refining capacity. The sense is that inflation is likely to stabilize and that is relatively good news. The ECB would like to see a bit more inflation as a means by which to goose the economy of Europe but Germany remains highly anti-inflation.




Step Towards Actual Tax Reform?

It is very early days yet and there will be many more hoops to jump through in the Senate and the House in the weeks and months to come but at least there has been some progress towards developing an actual plan for tax reform within the ranks of the Senate Republicans and nothing was going to happen until there was some degree of cooperation here. The crux of the debate has been what to do with the debt and deficit. One group of Senators really saw this as the most important issue and wanted a budget that profoundly affected both of these nagging fiscal issues. The other position was not necessarily in favor of higher deficits and debt but wanted to bring forward substantial tax cuts as a means by which to boost the economy. Within both positions there have been many disagreements on issues like how fast the debt should be paid down and who should be getting the tax cuts and how much. The compromise is still lacking detail but specific numbers should be forthcoming in the coming days.


Analysis: The battle from this point will be more than a little arcane. The GOP would like to have a tax reform effort complete before the mid-term elections and preferably before the primaries where many Republicans would be facing challenges from other party members that differ with these interpretations – some from the right and others from the left. To accomplish this the bill from the House and the Senate would have to be identical as that would permit the fast track process referred to as reconciliation. That would mean that a simple majority would be sufficient for passage through the Senate rather than a traditional 60 vote majority. This would mean passage with no Democrats voting in favor.

It is not going to be easy to get this identical 2018 budget passed through both houses as the current versions are significantly different in terms of deficit size, tax cut emphasis and even on the assumptions regarding ten-year growth. The fundamental assertion on the part of those seeking big tax cuts is that these will promote growth in the economy sufficient to drive more revenue accumulation and this would result in lower debts and deficits in the long run. For obvious reasons, this promotes a lot of fierce debate. A tax cut is productive only if there is the “right” use of that money. The corporation that receives a lower tax bill would need to use that gain to make more capital investments and to hire more people as it seeks to expand and grow. Many would pursue this course of action but not all. Some would take that tax break and distribute it to the stockholders and owners and this dilutes the impact of the additional money. Some would choose to expand through merger and acquisition and often that means dismissing redundant workers and closing some operations. The fact is that corporations will react in their best perceived interests and not all of this activity will be stimulating to the economy. There is also the fact that many factors affect the rate of growth for the economy besides tax rates. Will the US see growing export markets in the next ten years? Will the labor shortage become acute and cause a stall in growth? Will technology change the economy for the better or worse? This will depend on the industry and the job that one currently holds. The bottom line is that growth expectations are just that. There is no guarantee that tax cuts will achieve the desired end. On the other hand, there is a guarantee that nothing will happen if the tax rates remain high.

The legislation that passed the House of Representatives differs quite a bit from the Senate version at this point and the two will have to be reconciled before the fast track approach can be used. The House version does not permit a tax cut as deep as the Senate and demands $200 billion in budget cuts to reduce the size of debt and deficit. The Senate will have to vote on whatever comes from this reconciliation and in order to pass the Senate will not be able to lose more than two votes. Few of the Senators have staked out a position on this as yet but past statements suggest that there are several that would defect from both the hard-line and moderate wings. The debt and deficit hawks want a serious budget cut and the moderates are less concerned about the debt and more interested in tax cuts but with huge differences of opinion on who should be getting these cuts and for how long. This latest move is certainly a step towards some kind of tax reform agreement but most agree it is just a first and somewhat halting step.


Business Roundtable Survey Suggests More Hiring

The latest survey of the major corporations involved with the Business Roundtable indicates that most are in the mood to expand and that mean more hiring. The employment measure has risen to 80.2 and that is the highest that it has been in over six years. The motivation for this enthusiasm is still based on expectations and that causes a little concern should these expectations not be met. The assertion on the part of many of those polled is that there will be less regulatory pressure and they believe that tax reform efforts will be successful and result in lower burdens for the majority of them.


Analysis: The most tangible progress thus far has been regulatory as there has been a general relaxation of rules that had been inhibiting growth in several areas (most notably energy but also in the financial sector). There is less confidence regarding the tax reform efforts and several of the respondents indicated that they would likely revise their hiring plans if these cuts were not forthcoming. The responses indicate a belief that more pro-business attitudes are prevailing in Congress but there continues to be suspicion regarding Trump’s policies on trade and his interaction with the international community. The mess in North Korea continues to concern many as it seems the US is placing itself in a box. The hostility towards China and Mexico have been concerns to those heavily engaged in foreign trade activity.


Another Disaster – Another Economic Blow

It is far too early to know what the cost to Mexico will be from this latest earthquake. The focus is on rescue and officials are preparing for much higher death totals in the days ahead. Thus far there are 200 reported fatalities and three times that many injuries. Those assessing the damage expect much higher numbers in the days to come. Once the rescue operations become recovery operations the next task will be trying to determine what the country will need to do to recover. This has been a year of disaster in the Americas and the challenges are continuing as another hurricane is blasting Puerto Rico as this is being written and Maria may yet make landfall in the US. The countries and territories affected provide a range as far as response is concerned and Mexico is somewhat in the middle. There are those tiny Caribbean island countries and territories that have been utterly destroyed by Irma and have no means by which to recover. In contrast, there is the US where massive reconstruction is already under way in Florida and Texas. Mexico has far more in the way of resources than the Caribbean islands but far less than the US and this rebound will severely tax a budget which was not in great shape to begin with.


Analysis: Beyond the obvious initial challenge of rescue and immediate rehabilitation Mexico will be dealing with at least three issues that will combine politics with economics. The first is how this disaster will affect the upcoming Presidential elections, the second is how this will affect the Nafta talks and the third will be the overall impact on investment in Mexico from the US and Europe.

The national elections will be held in July of next year and the ruling party is worried given that polls have been slipping for President Pena Nieto. He is not allowed to run again but he needs a certain level of popularity in order to anoint his successor. His critics have blasted him on how he has handled the drug war and the sluggish pace of the economy and now he will be judged by how he reacts to this disaster. This is the backyard of chief rival “AMLO” – Andres Manuel Lopez Obrador. He was the leftist mayor of Mexico City some years ago and his influence there remains strong. Any misstep by the government will open the door for criticism and set up an even tighter race. The PRI will have to move very quickly to handle the crisis and will have to make major strides towards a recovery in a matter of weeks and certainly months.

The Nafta talks could be affected by this disaster as well. Mexico will be under even more economic strain than it was before and that will likely make them that much more protective of the pact. There will also be a certain amount of sympathy expressed towards Mexico although there has been little sign that the Trump administration will extend much. Canada has been quick to offer help and support but they are also committed to protecting Nafta and this would be in their best interests.

Finally, there is the long-term impact on investment and development. Will foreign operations think twice about committing large sums to a country that has now been hit by two large earthquakes in just a matter of weeks. Thus far the quakes have not been having a major impact on the manufacturing and industrial communities along the northern parts of the country but the quake in the south affected a major refinery operation and the capital city is home to a great deal of the service sector. The fear is that future quakes could damage that manufacturing infrastructure and this could inhibit further development.


AfD Likely to be Largest Opposition Bloc in Germany

The polls are in agreement for the most part. Angela Merkel will win another term as Chancellor as her Christian Democrats will emerge as the largest party in the Bundestag. The second place honors will be held by the Social Democrats and thus far that is as it has long been. What has changed is that the anti-refugee and populist AfD (Alternative fur Deutschland) will very likely be the third place finisher and will become the primary opposition party. It is expected that the Grand Coalition between the CDU/CSU and the SPD will continue in one form or another but the AfD has been rising in the polls and should take 85 seats in the Bundestag with around 12% of the national vote.


Analysis: The AfD has built its run on its aggressive position on the refugees and over time that position has hardened into overtly anti-Islamic policy. Members of the two main parties have asserted this collection of right wing populists contains “genuine Nazis” and that its supporters are virulently racist. That does describe many that back the AfD but not all are so neatly categorized. There are many who have been drawn to the German populists for the same reason that people supported the National Front in France and others. The world they knew has changed and left them behind and they are terrified there is no place for them in the future.


The Black Owl Report – An Executive Intelligence Brief

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Dealing with Adversity is a Lonely Struggle

There are many things we know intellectually but not emotionally. Some of this is simply self-preservation as we can’t become completely engaged in the travails of others as there is a limit to what we can do. The world is endlessly fascinated by the person who has defied the odds and has overcome. We are impressed with those who come back from illness and injury or who can rebuild their lives after a disaster or tragedy. And we should be – that struggle is extremely hard.

What we have to try to remember is that this can be a very long and excruciating process. Recovery from physical damage can take years of pain and drudgery and the majority of this is done alone. Emotional recovery takes even longer. We express our condolences but we move on – we have to take care of our own life and struggles. The person grappling with that emotional pain knows the sympathy doesn’t last long and too soon they hear people asserting they should move on. That is far easier said than done and anybody who has felt that pain of loss knows that feelings will resurface for the rest of their lives. This doesn’t mean they will never heal but the fact is that some pain never goes away.

All we can do as friends is to allow for the legitimacy of the pain. People rarely want unsolicited advice on what they should be feeling. What we really want is simply presence. We just need to know that people are trying to understand and are willing to offer to be there – even if it is to just sit quietly and let us talk. Over the years we all lose people we love and suffer significant setbacks. My wife has beaten ovarian cancer twice and both times I thought my life would end. I still miss my dad 35 years after his passing. These feelings come back on occasion and I am very glad that I have friends that understand and just listen.


This is a commentary by Keith that appeared in this week’s 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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Wells Fargo Thoughts on Potential 2018/2019 Recession.  Wells Fargo analysts have done some great work on predicting recessions. The difference between what they have worked up and the charts we watch, is that they can get about 17 months ahead of market conditions to predict recessions. Here’s what they said about the risk for 2018/2019:


“We have proposed a new framework using the fed funds rate and the yield on the 10-year

Treasury security to predict recessions. Our framework has predicted all recessions since 1955

with an average lead time of 17 months. Furthermore, we are forecasting one more rate hike in

2017 (December), and, in the case of a rate hike, the threshold will be met for this cycle.


Therefore, starting in December 2017, there is an increasing probability of a recession in the

coming years.


It is important to note that, at present, our official call is for continued moderate growth in 2018-

2019 (around 2.5 percent GDP growth rate) and this framework suggests a downside risk to our forecast. Therefore, we are not making an official call for a recession over the two-year forecast horizon.


Instead, decision-makers may want to watch 2018 through mid-2019 for potential slowdown/recession. But, mindful of the analysis we have performed in this report, we will be

watching incoming data closely to determine whether conditions that could lead to a

recession/slowdown starting in late 2018 are developing. We would encourage decision-makers to

do so as well.” – Wells Fargo Securities


Summarizing for Wells Fargo: we should be near recession because of a relationship between the 10-year treasury note and the Fed Funds rate.  The “spread” between the two is suggesting that we are near recession levels. We still would need to see the St. Louis Financial Stress Index (SLFSI) move above zero before we would consider a recession risk to be elevating. The only problem in using the SLFSI is that it can swing quickly.  We won’t get a significant lead-time.

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