First Quarter 2016 Investment Climate: The Economy

Economic Factors

  1. New Factory orders, shipments and inventories:  This is a net negative.  Factory Shipments and New Orders have been declining.  Presently, Factory shipments (down $35 billion from recent peak in November 2014) are lower than at any point since March 2012.  New Factory Orders (down $41 billion from recent peak in August 2014) are sitting at levels equal to those we last saw in 2013.  Meanwhile, Factory Inventories are at a record breaking level of $637 billion.   Inventories exceed Orders and Shipments by $170 billion, the largest spread since I have been tracking this data going back to 1990.

 

  1. Business sales and inventories:  Business Sales are at 71.53% of Business Inventories.  The fall in this relationship is dramatic, dropping from roughly 80% back in 2012.  At this point the relative comparisons to the recessionary periods of 2009 and 2002 are on point as they are the only recent periods in which sales represented such a low percentage of current inventories.  Business sales are down $70 billion since the Summer/Fall of 2014, whereas Business Inventories are up $65 billion over the same period.

 

 

  1. Employment:  The persistent and continued improvement here is encouraging.  Weekly unemployment claims, average weeks unemployed, and long-term unemployment are all improving.  Weekly claims, long-term unemployment, and the broadest measure of unemployment (U6) are all below the levels that existed in 2008, prior to the Great Recession.

 

  1. Home prices:  Median ($301,400) and Average ($348,900) New Home prices in the United States are higher now than at any point in the last twenty years.  For homeowners this is very positive and feeds confidence in the area of financial security, and contributes to an overall improvement in consumer confidence.  The however in this area is the lack of rising incomes, which means home affordability is falling.  U.S. Household Incomes, both Median ($53,657) and Average ($75,738), are presently equal to the level that existed in the year 2000.  This is a risk that weighs on the future, for rising home prices that are dependent on low interest mortgage rates will not persist in the absence of rising incomes.  New supply of housing is improving as we move from the low of 500,000 annualized units during the Great Recession to a level of 1.2 million units now.  This is still meaningfully below the 2+ million units in 2006, and approximates the lows of the 1990/91 recession.  Population growth supports a rising housing market, but absent incomes to enable purchases we find we are in a “renters” market vs a healthy expanding housing market.

 

  1. Steel production, Electricity usage, Baltic Dry index:  These are all troublesome if we are looking for signs of positive economic activity that point to self-sustaining vibrancy.  US Steel production at 1.7 million tons is 400 million tons below the levels of 2008.  Electricity usage is relatively flat.  The Baltic Dry index as a measure of Ocean transport has simply collapsed since 2013, falling by over 80%.  We have seen a recent quarter over quarter slight pick-up in the Baltic and will need to watch this for more favorable signs of global trade, however we are still at historically low rates.

 

  1. Domestic autos:  Nice improvement since the recession, as Domestic Auto sales have doubled since 2009.  The current level is still meaningfully below the historic sales levels (we are at 25% of the sale levels that existed in the year 2000), and this indicates a rising age of vehicles in the US and a future demand curve that is hopeful.  Rising incomes, just as in the home price discussion, are needed to unlock greater demand here.  Of concern is the rising level of auto sales being funded by debt over extended lives.  An exhaustion of debt capability should be watched as a limiting factor of continued improvement absent a more meaningful level of economic and income growth.

 

  1. US Construction spending:  Spending on public and private construction in the US has rebounded since the recession, with current levels approximately 50% above the recessionary lows.  Double digit annual growth has been evident here for the past two quarters and this is a real bright spot in economic stimulus.   We are back to 2007 levels in terms of spend. The opportunity for Public works projects to address infrastructure needs of the country is real and meaningful, and this could be seen as a needed catalyst to income levels and overall quality of employment.

 

  1. Lending growth: The rate of growth in lending activity has been moving higher, and could be a sign that the level of Free Reserves in our financial system are slowly starting to react to the continued low level of earning opportunity of money parked within the system.  The annual rate of loan growth is presently running at an 8% level, and has been at this rate of growth for the past three quarters.

 

  1. Dollar Strength:  The strength of the dollar versus other currencies has been volatile but moderating of late.  The rapid rise of the dollar’s strength since 2014 is now moving within a defined band.  From January 2015 thru March 2016 the dollar has traded within a band of 90 to 100.  This compares to the 2014 range of 79 to 90.  Over the past six months the dollar has traded between 95 and 100, mitigating FX impacts on YoY comparisons.  With Central Banks across the globe lowering rates and adding liquidity, coupled with the modest to slowing US economic growth and stated completion of Quantitative Easing by the US Fed, the demand for dollars and dollar denominated assets remains very real.  The impact on US multi-nationals’ forward revenues and earnings should be less dramatic given greater stability in exchange rates.  A lack of currency volatility that may emerge as the new norm going forward should benefit Emerging Markets and the commodity trade.  Additionally, the dollar stability and strength will deliver benefits through greater global expansion of US businesses as dollars are used to finance acquisitions of assets outside the US.

 

  1. Yield spread Investment Grade vs High Yield:  Spreads are narrowing after a blow-out in the first six weeks of 2016.  This indicates less risk is perceived to be in the system from High Yield loans to the commodity borrowers and from European Banks.  The current spread between U.S. Investment grade and high yield corporate debt is on average 4.8%.  The spread between ten year treasuries and intermediate grade Corporate debt is 3.34%.  These are modest premium spreads by historic standards, but are elevated compared to where they stood a year ago (approx. 100 basis points higher).   A flattening of the yield curve is a bit of a concern, as hints of a recession continue to be present.

The Year over Year trend in economic data by quarter is presented below.  The employment data is very encouraging.  The goods and production data is recessionary in tone.  The consumer and construction spending are positives.  Deflation and trade concerns are real

Historic YoY Comp 31-Mar-16 31-Dec-15 30-Sep-15 30-Jun-15 31-Mar-15
DJIA -1% -2% -4% 6% 9%
DURABLE GOODS -2% -4% -3% 2% 4%
DURABLE CONSUMPTION -1% -1% -1% 1% 4%
DURABLE ORDERS 1% 0% -4% -4% 1%
FACTORY INVE -2% -2% -1% 0% 2%
FACT SHIPMENTS -2% -5% -4% -4% -2%
FACTRY OP RATE -3% -4% -2% -1% 0%
NEW FACT ORDERS -1% -5% -6% -5% -2%
BUSINESS SALES -1% -3% -3% -2% 0%
BUSINESS INVE 2% 2% 3% 3% 3%
DOMESTIC AUTOS 1% -15% 1% -1% -12%
CONST SPENDING 10% 13% 14% 5% 2%
NEW HOUSING STRTS 31% 16% 17% 5% 19%
CONSUMER SPENDING 4% 2% 3% 4% 3%
PPI -2% -3% -2% -3% -4%
LOANS 8% 8% 8% 8% 8%
FREE BANK RESERVES -9% -10% -6% -4% 3%
AVG NEW HOME PRICE 0% 14% 4% 5% 8%
MEDIAN NEW HOME PRICE 2% 0% 8% 3% 13%
MEDIAN HOUSEHOLD INCOME -1% 3% 0% 2% 2%
MEAN HOUSEHOLD INCOME -1% 4% 0% 1% 2%
ELECTRIC POWER -4% -2% -2% -6% -3%
BALTIC DRY INDEX -33% -38% -14% -1% -57%
STEEL PRODUCTION 6% -17% -6% -8% -13%
EXPORTS -1% 1% 1% 3% 3%
IMPORTS 2% 6% 5% 7% 6%
INITIAL JOBLESS CLAIMS -10% -2% -5% -13% -9%
CONTINUING CLAIMS -7% -7% -10% -13% -14%
AVG WEEKS UNEMPLOYED -8% -15% -17% -10% -14%
U-6 -12% -13% -15% -11% -13%

Author: Thomas Connolly

Tom possesses a rich and diverse background that includes deep investing experience, senior corporate executive positions, and roles as a Regional Managing Partner and Global Industry Leader within Ernst & Young. He has advised executives on some of the largest acquisitions and dispositions in the Media and Entertainment industry, including clients such as Comcast, Citibank, Sony, Dalian Wanda and Publicis. Tom is a Certified Public Accountant with a Masters Degree from Columbia University. His skills are further accompanied by a personal passion for the study of economic trends and evolving market dynamics.

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