The Days Ahead: Small business survey. Fed minutes.
One-Minute Summary Two of the three big economic data disappointed last week. The two ISM surveys for the manufacturing and service business showed caution and weakness. The third, employment, was ok. That's all. Just ok. Other data like trade were weak but anyone keeping tabs on tariffs knows this number is heading in the wrong direction. The U.K. prime minister put forward an unfeasible deal on Northern Ireland knowing full well the EU will reject it. There are 27 days until Brexit. The U.S. placed tariffs on European aircraft and some agricultural goods. Not unexpected as it was the result of a subsidy claim filed over 15 years ago. Impeachment? Markets don't know how to price in politics.
Bonds had a good week, with the 10-Year Treasuries at 1.51%. That's about where it was a month ago. The yield curve points to a slowing economy and some Fed easing. Nothing new there. Stocks had a 4% sell-off midweek but then recovered with just a 0.3% loss for the week.
Let's’ face it. Stocks are drifting in the 2700-3000 range. They can't really break out until either trade, EU fiscal or political risk look a whole lot better. We’re not holding our breath.
1. How’s manufacturing doing? Well, you know…terrible. We've known for a while that manufacturing was having a tough time with the global slowdown, China and the trade talks. Manufacturing accounts for around 12% of GDP. It employs around 12.8m people or 10% of the workforce. That’s lower than it was in the depths of the 2009 recession. Automation, offshoring and trade have continued to erode the manufacturing base. But it’s still important because it has a high multiplier effect. A service job can exist on its own. Manufacturing tends to provide ancillary jobs, such as transportation, raw materials, suppliers and distribution.
Thanks to the trade war, confidence has fallen to its lowest since 2009 (the blue line):
And export orders (black line) are at the second lowest level seen in 30 years. I mean, who would have guessed? If you hike import prices by 20% you’ll either see inflation or a collapse in demand. You certainly won’t see companies increase their exports.
Some of the comments from respondents were telling. Here’s one:
“We have seen a reduction in sales orders and, therefore, a lower demand for products we order. We have also reduced our workforce by 10 percent.”
Not one company said that the cost of capital was a problem. So lower rates won't make a difference. We'd note the ISM index has triggered false alarms before. But if these numbers continue then, yes, the Fed will cut rates for sure.
On the investment side, companies in the industrial chemicals, machinery, energy, auto parts and machinery sectors have had a miserable 12-month performance. We've underweighted those for the most part and would continue to do so.
2. Any tariff update? Yes, all sorted. We won. Nothing to see. Ha, no, of course not. Last week the WTO agreed with the U.S. that the EU unfairly subsidizes Airbus. This has been an open case at least since 2005 with i) Boeing claiming unfair annual subsidies for Airbus running at $7bn to $10bn and ii) Airbus claiming unfair military contracts for Boeing. But guess what? The WTO, which the U.S. doesn't like much anymore, said, “Yes, U.S. you have a point and you can take countermeasures up to $7,496,623,000”. Curiously specific but there you go.
So on the same day, the U.S. issued their own tariffs. Basically it’s 10% on big planes and 25% on a ton of agricultural and manufactured goods. Long list here. It includes wines, olive oil from Spain, France and Germany but not Hungary.
The Airbus side of the case will rule next year so the likelihood that the EU will retaliate on Boeing seems very high. Meanwhile, we have a case study of what happens with tariffs from January 2018 when the Administration passed a 20% tariff on washing machines.
Now there are only four companies selling washing machines in the U.S. and Whirlpool (who also make Maytag) liked this deal very much. They immediately increased prices by around 20% that ended up costing consumers around $1.5bn. There it is. That rather large spike in prices in early 2018. The amount raised by the tariffs? $82m. They also increased prices on dryers. Hey, why not.
Our guess is that every Napa wine owner is planning a 24.99% price increase for October 19th.
So do tariffs hurt consumers? Yes.
All of this continues to upset markets. The immediate reaction was for the big airline stocks to fall around 5%. We have some exposure through Berkshire Hathaway but it’s small and the airlines have other problems.
3. So on the “soft” data not so good. How about the “hard” data? Better. Friday’s job report was below estimates but still at 136,000. The labor force grows at around 100,000 a month so anything more than that will reduce unemployment. That’s a very raw description, I know and it’s horribly seasonal but it’s roughly in line with the census information.
A few quick points:
Private sector employment was down. We'll watch this closely as census employment starts in earnest in a few months and it can add 300,000 temp workers to the new jobs list
Average hourly earnings did not grow at all over the month but are still 2.9% up on the year
The two ISM reports last week point to less hiring.
This just shows new jobs and the ISM numbers for employment intentions. We advance the latter just to show its relationship to actual results. It clearly points to a slow down in hiring at the back end of the year.
As we've said, there is a huge difference between hard data (actual jobs, wages, sales) and soft data (confidence, intentions, expectations). Last week was bad on the soft side but ok on the hard side. That’s what makes the timing of the Fed’s next move tricky. It will be October or December. Perhaps both. Either way, there is more upside potential in Treasuries than downside risk.
4. WeWork Bonds. Yes, they're a thing. So far only Softbank, some venture firms and employees have taken a hit. But WeWork issued bonds last year that S&P and Fitch just downgraded to junk.
Why do we keep going on about a non-public company that had fraud and mismanagement written all over it? Because we think it’s good sign that the public markets said “No”. Loudly and clearly. And that tells us that investors remain cautious. As are we.
Bottom Line: The only surprise last week was the manufacturing business confidence took a dive. It’s nearly all trade and China. And it’s nearly all self-inflicted. We expect things like GDP, job growth and wages to slow in Q4. But all of that’s priced in.
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