Monday, 25 of March of 2019

Economics. Explained.  

Category » Miscellaneous

S&P 500 Stock Prices

March 15, 2019

The S&P fell 20% in the fourth quarter of last year.   The market appeared to be concerned about a variety of factors.  The expansion is approaching its tenth anniversary which is geriatric, so some economists fear that,for that reason alone, the end of the expansion must be close.  It was seeing growth weakening overseas, particularly in China which is the world’s second largest economy.  It feared a trade war could weaken growth further.  The Fed indicated that intended to raise rates twice in 2019.  And it saw the housing market fall steadily for most of last year.

But heading into 2019 growth the view has changed.  Growth overseas appears to have stabilized.  The Fed has said that it intends to leave rates unchanged for the foreseeable future.  Mortgage rates have fallen 0.5% since the end of last year and  home prices are declining.  These two factors should re-invigorate the housing sector in the months ahead.  Thus, the economic fundamentals in our view remain solid.  That change in outlook has allowed the stock market to rebound and erase nearly all of the fourth quarter drop.  Indeed, it is currently within 3.5% of an all-time record high level.

Given the positive combination of moderate GDP growth, low and still stable inflation, and the likelihood of no further rate hikes, we fully expect the stock market to reach another record high level, probably by midyear.

 

Stephen Slifer

NumberNomics

Charleston, SC


Trade Deficit

March 6, 2019

The trade deficit for December surprisingly widened by $9.5 billion to $59.8 after having narrowed by $6.0 billion in November.     Exports declined 1.9% in December.  Imports jumped by 2.1%.  This means that the trade deficit for the year was $621 million which consisted of a goods deficit of $891 million combined with a services surplus of $270 million.  The $891 million trade deficit in goods is a record high level.

Everybody is talking about the record trade deficit for goods.  Trump started imposing tariffs last year in an effort to shrink the trade deficit but, instead, it widened considerably.  But before we get too excited, if we ultimately get renewed deals with Canada, Mexico, the E.U., the U.K., and China (perhaps among others),  those agreements call for those countries to open their markets, reduce tariffs, and import more goods from the U.S.   Thus, the trade gap may well shrink over time as exports climb.  But right now, those countries are racing to get goods into the U.S. before the new tariffs become applicable.  As a result, imports surged late in the year.  So, it is entirely possible that after this late year surge, the deficit will shrink rather sharply in the first part of this year.  We’ll see.

We certainly support the notion of free trade.  Through trade American consumers have access to a much wider variety of goods and services at lower prices than they would otherwise.  But there are a couple of important points.  First, free traders (like us) assume that there is also fair trade.  That is the rub.  The Chinese in particular, and others, do not play by the same rules as everybody else.  Second, the yawning trade gap perhaps indicates that current trade agreements like NAFTA, as well trade agreements with Europe and Japan, were not well negotiated and allowed other countries to take advantage of the U.S.    One can make a case that the U.S. has been subsiding growth in other countries at its own expense for years.  Trump has decided that is true and has chosen to impose across-the-board tariffs.

Personally, we think the focus on the magnitude of the trade deficit is misplaced.  A $900 billion trade gap simply means that we bought more from foreigners than they bought from us.  As a result, foreigners accumulated $900 billion of dollars that will be re-invested in the U.S.   Those people might establishes businesses here in the U.S., hire American workers, or invest in our stock and bond markets.  It is not the magnitude of the trade deficit that bothers us.  But, as shown below one-half of that trade gap is with one country — China.  We do not have yawning trade gaps with Canada, Mexico, Europe, Japan, or OPEC.  If Trump is truly concerned about the magnitude of the trade deficit, he should have targeted those countries where it was the largest, namely China.  But he didn’t he chose to impose tariffs across the board which impacted our neighbors, friends and allies alike.  Not surprisingly, the U.S. tariffs generated retaliation by many other countries and it appeared that a trade war was underway.

But as the trade war got started investors around the globe tried to figure out which countries might fare best in a trade war.  Answer:  U.S.  Why?  Because trade is only 10% of the U.S. economy.  It is about 50% of everybody else’s economy.    Everybody loses in a trade war, but the U.S. may lose far less than others.

As other countries began to believe that the U.S. could withstand a trade war better than anybody else,  foreign investors flooded into the U.S. stock and bond markets.  The dollar soared.  That money would be used to create new businesses in the U.S., hire more American workers, and boost our stock market.  Elsewhere, the opposite was occurring.  Currencies were weakening, stock markets were falling, growth was slowing.  The U.S. was winning, the rest of the world was losing.  The question quickly became, how long could these countries withstand the pain?  The answer is apparently, not long.  A new agreement has already been reached with Mexico and Canada.  We are negotiating with Europe.  A deal with China may not be far off.

This has been a painful and perhaps scary process to see in action but, in the end, we may end up with both freer and fairer trade than we had initially.

Frequently exports and imports can be shifted around by price changes rather than the volume of exports and imports.  Thus, what is really important is the trade deficit in real terms because that is what goes into the GDP data.  The “real” trade deficit widened by $10.0 billion in December after having narrowed by $7.5 billion in November.

Increasing energy production in the U.S. is having a significant impact on our trade deficit in oil.  Since 2007 real oil exports have almost quintupled from $4.0 billion to $22 billion, while real oil imports have fallen from $42.0 billion to $30 billion. As a result, the real trade deficit in oil has been cut by about $30.0 billion or 75% in the past several years and is the smallest since the early 1990’s.  In March of last year the U.S. surpassed Saudi Arabia and Russia  and become the world’s biggest producer of oil.  By the end of the decade it should also become a net exporter of oil.  Very impressive!

The non-oil trade gap has widened significantly  in the past year to about $76.0 billion as non-oil exports fell 2.6% while non-oil imports climbed by 3.4%.

Stephen Slifer

NumberNomics

Charleston, SC


Small Business Optimism

February 12, 2019

Small business optimism fell 3.2 points in January to 101.2 after having declined 0.4 point in December to 104.4.  But given the return of divided government, the partial government shutdown, and uncertainty about the next round of tariffs, the January level remains robust.  Keep in mind that the August level of 108.8  broke the previous record high level of 108.0 set 35 years ago back in July 1983.  So while confidence has slipped in recent months, it has fallen from a record high level.

NFIB President Juanita Duggan said,  “Business operations are still very strong, but small business owners’ expectations about the future are shaky.  One thing small businesses make clear to us is their dislike for uncertainty, and while they are continuing to create jobs and increase compensation at a frenetic pace, the political climate is affecting how they view the future.”

NFIB Chief Economist added that, “Although January’s index showed some positive developments among current business conditions, the return to divided government in Washington created an inability to agree on basic policy measures.  This produced the longest partial government shutdown in history, elevating the level of uncertainty, which is damaging to economic activity.”

In our opinion the economy is expected to expand at a reasonably robust pace this year.  Specifically, we believe that the cut in the corporate income tax rate, legislation that will allow firms to repatriate corporate earnings currently locked overseas back to the U.S. at a favorable 15.5% rate, and the steady elimination of unnecessary, confusing and overlapping federal regulations will boost investment.  That, in turn, should boost our economic speed limit should from 1.8% or so today to 2.8% within a few years.

After falling 20% late last year the stock market has recovered much of the earlier loss.   Jobs are being created at a brisk pace.  The unemployment rate is well below the full employment threshold.  Mortgage rates have fallen in the past couple of months from 4.9% to 4.7%.  And investment spending remains solid.  We expect GDP growth to be 2.7% this year after having risen 3.1% in 2018.  The core inflation should be relatively stable at 2.4% in 2019 after rising 2.2% in 2018.  The Fed will continue to raise short-term interest twice this year but the hikes will not occur until after midyear.  Moderate GDP growth, low inflation, and low interest rates should continue to bolster the stock market in the months ahead.

Stephen Slifer

NumberNomics

Charleston, SC


Corporate Leverage

December 13, 2018

Economists like to keep an eye on the amount of leverage amongst corporations.  When corporations take on huge amounts of debt in relation to their net worth, any economic downturn will be much more severe than it would otherwise be as corporations become unable to service their debt from cash flow.  However, in the third quarter of 2018 the ratio of corporate nonfinancial debt  to net worth was 37.9%.  This compares to an average ratio of debt to net worth since 1980 of 40.3%. There is no reason to think that the economy is at risk from excessive corporate borrowing.

Stephen Slifer

NumberNomics

Charleston, S.C.

 


Corporate Cash

December 13, 2018

Corporate cash holdings rose $49 billion in the third quarter to $2.62 trillion (above).  At 9.1% they are a shade lower than their long-run average of 9.4% of non-financial assets (below).  The problem with this series is that every time the Fed adds data for a new quarter, the history of the series going back for years will also change, and the relationship between corporate cash and financial assets will get revised.   It is hard to make any meaningful analysis when a series is subject to sizable revisions.

Stephen Slifer

NumberNomics

Charleston, SC


Corporate Profits

November 28, 2018

Corporate profits before tax with inventory valuation and capital consumption adjustments rose 3.4% in the third quarter to $2,318.4 billion after having risen 3.0% in the second quarter.  During the last year profits on this basis have risen 10.3%.  The IVA and CC adjustment deals with the difference in depreciation allowances used for accounting and income tax purposes.  Hence, changes in tax laws impact this series and it does not accurately reflect profits from current production.

Corporate profits before tax without such adjustments, or profits from current production, rose 1.1% in the third quarter to $2,220.5 billion after having jumped 4.1% in the second quarter.  Over the course of the past year such profits have declined 0.5%.  However, we expect this series on profits to rise at about a 7.0% pace for the year as a whole.

The economy climbed at a 2.5% pace in 2017 and  we expect it to rise at a 3.1% pace in 2018 and 2.8% in 2019.  Inflation will rise modestly and interest rates will rise slowly but remain low.  In addition, corporate profits will benefit from a cut in the tax rate, and by a significant reduction in their regulatory burden.  As a result, corporate profits should climb at roughly a double-digit pace in both 2018 and 2019.

Stephen Slifer

NumberNomics

Charleston, SC


Trade-Weighted Dollar

August 10, 2018

The trade-weighted value of the dollar, which represents the value of the dollar against the currencies of a broad group of U.S. trading partners has risen 4.3% from where it was at this time last year.

When you try to figure out the impact of currency movements on our trade, you have to weigh the movements depending upon the volume of trade we do with that country.  For example, our largest trading partners are:

With respect to the Chinese yuan the dollar has risen  about 2.4% over the past year.  A year ago one dollar would buy 6.67 yuan.  Today it buys 6.83 yuan.

The U.S. dollar has risen 3.1% versus the Canadian dollar during the past year.  For example, a year ago one U.S. dollar would purchase $1.26 Canadian dollars.  Today it will buy $1.30 Canadian dollars.

And against the Mexican peso the dollar has risen by 4.6% during the past year.  A year ago one dollar would buy 17.8 Mexican pesos.  Today it will buy 18.6 pesos.

The dollar has weakened by 0.1% against the yen during the course of the past year.  A year ago one dollar would buy 129.7 yen.  Today that same one dollar will buy 129.5  yen.

The dollar has risen 1.6% relative to the Euro during the past year.  A year ago one Euro cost $1.18.  Today one Euro costs $1.16.

Thus, the dollar has strengthened against almost every major currency during the course of the past year.  As a result, the trade-weighted value of the dollar, as noted earlier, has risen 4.3% during the past year.

Currency changes can affect the economy in several ways.   First, a rising dollar can reduce GDP growth of U.S. exports because U.S. goods are now more expensive for foreign purchasers to buy.  Similarly, a rising dollar can increase growth of imports because foreign goods are now cheaper for Americans to buy.  Fewer exports and more imports will reduce GDP growth that year.  A rising dollar can also reduce the rate of inflation in the U.S. because the prices of foreign goods are now lower.  A falling dollar will do the opposite — increased growth in exports, slower growth in imports, and a faster rate of inflation.

From October 2014 to January 2016 the dollar rose 22%.  That is a huge change.  The trade component subtracted about 0.5% from GDP growth in both 2014 and 2015.  A 4.3% increase in the dollar in 2018 is expected to reduce GDP growth this year by 0.3%.

The dollar’s recent strength is attributable to the widespread imposition of tariffs and sanctions by the U.S. which are believed to reduce growth in other countries more than they weaken growth in the U.S.  While changes in the value of the dollar relative to the currencies for our major trading partners have been noted above, it is also important to recognize that the combination of tariffs and sanctions has strengthened the dollar by 18.8% against the Brazilian real, and by 13.4% against the Russian ruble.  The emerging economies have been particularly hard hit.

Stephen Slifer

NumberNomics

Charleston, SC


Business Inventories / Sales Ratio

May 8, 2018

Firms are always trying to keep their inventories in line with sales.  When the economy falls into recession, typically businesses do not cut back production as quickly as sales decline, so the inventory/sales ratio rises sharply  — which is exactly what happened during the 2008-2009 recession.  Then, as the economy recovers and sales once again begin to rise, corporate leaders are able to  get inventory levels into closer alignment with sales.

In February business sales rose 0.4% while inventories climbed by 0.6%.  As a result, the inventory to sales ratio was essentially unchanged at 1.35.  In recent months sales have outpaced inventories and the inventory/sales ratio has fallen.  A faster pace of sales will eventually require business people to step up the pace of production to build inventories  to ensure that they have adequate supplies on hand.  That seems to be happening now.

Stephen Slifer

NumberNomics

Charleston, SC


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