Sunday, 30 of April of 2017

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Category » Commentary for the Week

The Tax Plan is a Good Thing – But Not Revenue Neutral

April 28, 2017

The long-awaited Trump tax plan is still sketchy on details but, on balance, it is a good thing.  It will stimulate investment spending which will, in turn, boost productivity growth. Faster productivity growth will lift the economic speed limit for the U.S. economy from 1.8% currently to perhaps 3.0% by the end of the decade.  Unfortunately, that is not the 3.5-4.0% growth rate that President Trump envisions. To the extent that actual growth falls short of that mark his package will not be “revenue neutral”, which means that the budget deficit and debt outstanding will increase.   The deficit is already on a path to hit $1.4 trillion annually by 2026.  Any further increase is undesirable.  However, stimulating GDP growth to a 3.0% pace will create jobs, raise wages, and increase the growth rate in our standard of living.  It seems to us that the positive impact of these proposed tax cuts on the economy far outweigh the negative impact on the deficit which, as described below, may be far smaller than the Congressional Budget Office estimates.

How fast can the economy grow?  The economy’s speed limit is the sum of two numbers:  the growth rate of the labor force plus the growth rate of productivity.  Back in the 1990’s the labor force climbed by 1.5%, productivity was growing by 2.0%, which means that the economy’s speed limit (or potential growth rate) was 3.5%.  Today, however, the labor force is climbing by 0.8%, productivity is growing by 1.0%, so the speed limit has dropped to 1.8%.  The slow labor force growth largely reflects the impact of retiring baby boomers which will continue for another decade.  To boost the speed limit policy makers must boost the growth rate of productivity.  That growth rate, in turn, is determined largely by the pace of investment spending.

That takes us to the Trump tax policy.  It is focused largely on the business community.  He proposes to cut the corporate tax from 35% to 15%.  The lower rate applies to businesses of all types – corporations, partnerships, and small businesses of all sizes.  He plans to impost a one-time tax on an estimated $2.6 trillion of corporate earnings that are currently parked overseas.  And he proposes to end taxation on offshore income by adopting what is known as a “territorial” tax system which means that U.S. companies will pay no U.S. tax on income earned overseas (rather than the 35% rate they would pay under the current system).

At the same time he plans to simplify the individual tax code from seven tax brackets currently to three – 10%, 20%, and 35%.  He would end the alternative minimum tax and eliminate the estate tax.  He would simultaneously eliminate all itemized deductions except for home mortgage interest and charitable giving.

Tax cuts of this magnitude will reduce tax revenues and boost the budget deficit.  That scares people who are legitimately concerned about budget/federal debt issues in the years ahead.  But what if the proposed tax cuts boost GDP growth from 1.8% today to something higher like 3.0%?   The additional income generated by faster GDP growth will enhance tax revenues and, at least partially, offset the impact of the tax cuts.

Trump has said he expects the tax cuts to boost GDP growth to 3.5-4.0%.  His tax plan documents do not specific his specific growth assumptions, but he has talked about numbers in that ballpark in the past.  That is a reach.  Go back to the potential growth rate equation.  Labor force growth is probably going to be stuck at about 0.8% for another decade as the boomers continue to retire.  For Trump to reach his goal he needs productivity to accelerate to 2.7-3.2%.  Therein lies the problem.  Looking back over the past 40 years there is only one period when productivity climbed at a 3.0% pace for any protracted period of time.  That was the late 1990’s and early 2000’s which reflected the introduction of the internet in the mid-1990’s followed by the cloud and apps in the early 2000’s.  That was an unprecedented period of development.  It is unreasonable to expect productivity growth of that magnitude as the result of tax cuts.  However, to believe that productivity growth could be 2.0-2.5% is not unrealistic.  That would boost potential GDP from 1.8% today to 2.8-3.3% (0.8% growth in the labor force plus 2.0-2.5% growth in productivity).  If he is successful in boosting potential GDP to roughly the 3.0% mark that makes his tax reforms and tax cuts a desirable package.

But 3.0% GDP growth is not 3.5-4.0%, and tax revenues would fall short of the White House’s projections. Given that the budget deficit is already projected to climb from about $500 billion currently to $1.4 trillion within a decade that is not a desirable outcome.  However, if GDP growth jumps to 3.0% and Trump anticipates growth or 3.5-4.0%, the shortfall should be relatively small.

If, in addition to his proposed tax cuts, Trump is willing to consider cuts in so-called entitlement expenditures such as Social Security, Medicare, and Medicaid he could achieve faster GDP growth and no long-term increase in the budget deficit.  Such a combo would be deemed as “revenue neutral”.  That would be the best of all possible worlds.

Republicans and Democrats agree that tax reform is long overdue.  Hopefully, they can agree on a “revenue neutral” package of tax cuts and reduced spending similar to what was just described.  The bipartisan Erskine-Bowles Commission agreed on such a package back in 2010.  If seven years ago a bipartisan group of Republicans and Democrats could reach an agreement on what needs to be done, they can do it again.

The issue of revenue-neutrality is more than just an academic issue.  To boost the deficit outside a 10-year window requires a two-thirds majority in the Senate, i.e., it would need support from some Democrats.  A simple majority can pass the bill, but it would expire at the end of 10 years.  A major tax overhaul should clearly be a permanent change not a temporary one.

Hopefully, some agreement can be reached to make these proposed changes revenue neutral and thereby permanent.  But if that is unattainable, temporary changes in the tax code that produce faster GDP growth, more jobs, higher wages and faster growth in our standard of living are a desirable alternative.

Stephen Slifer


Charleston, S.C.

Growth Remains Moderate – Weather Distorts Data

April 21, 2017

Early in the year it appeared that the economy was in the process of taking off.  Three months later it has seemingly slowed dramatically.  But monthly data swings are the norm, not the exception.  As we see it, the economy continues to chug along at about a 2.0% pace.  Expectations were too high earlier and they are too low today.  In this case, most of the shifting expectations are attributable to nothing more than the weather which frequently tends to muddy the outlook at this time of the year.  Specifically, the warmer than normal weather early in the year boosted everything from employment, to retail sales, to housing starts, and interest rates.  Once the weather returned to normal suddenly all of those indicators seemed weak.  It is sometimes hard to look past the monthly wiggles and the associated knee-jerk reaction by the markets.  But, more often than not, it is the right thing to do.  Not to worry, growth remains at a steady – if unimpressive – pace for now with somewhat faster growth likely in the quarters ahead.

In December, January, and February virtually every economic indicator seemed strong.  Employment gains surged to about 200 thousand per month.  Housing starts climbed 10% or so from 1,150 thousand from 1,275 thousand.  Retail sales jumped 1.0% in December and an additional 0.5% in January.  The inflation rate climbed by 0.3% in December and another 0.6% in December.  With the economy at full employment the fear was that this additional strength would boost the inflation rate far above the Fed’s 2.0% target and force the Fed to raise short-term interest rates more than three times this year.  Good news.  Bad news.  The economy was doing better, but the Fed might have to raise more quickly than expected to cool things off.

The March data provided an entirely different picture.  Employment slid to just 98 thousand.  Housing starts fell almost 7%.  Retail sales declined 0.2%.  The inflation rate fell 0.3%.  Suddenly expectations shifted.  The economy wasn’t expanding too rapidly after all.  The inflation rate might not surge.  The Fed does not have to panic.  It can afford to maintain its go-slow trajectory for raising interest rates.

While perfectly understandable, it is hard not to get caught up in the enthusiasm (or disappointment) of the moment.  Which is why we always recommended looking at 3-month averages which smooth out some of the monthly distortions.  Longer-term averages, like year-over-year growth — even out the data so much that changes in trend may not be discernible for months.  That is not good either.

In this case, the apparent surge and subsequent slowdown were clearly impacted by deviations from normal winter weather patterns.   In other recent years we have seen surprisingly harsh winter weather conditions depress the early year data.  By spring the weather returned to normal and pent up demand caused sales to surge.  This year was the opposite.    January and February were much warmer than normal in most areas of the country.  Builders were able to dig some holes in the ground and begin construction on a number of new houses and apartments.  Consumers took advantage of the mild weather conditions and went shopping for cars and other goodies.  Perhaps they bought some garden equipment they might ordinarily have bought a couple of months later.   In March when those housing starts and sales would ordinarily have occurred they did not materialize because they had actually taken place a couple of months earlier.

Are those swings in economic activity legitimate?  Yes.  Do they mean much?  No.  At some point the weather will return to normal and, in this case, people should have expected the March data to be as weak as the January and February data were strong.  But markets are markets and they react to each new data point.  But you, dear readers are able (most of the time) to sift through the monthly wiggles and keep your eye on the trend.  As we see it, the housing market is steady and builders will gradually boost the pace of production.  Consumers are continuing to spend at a moderate rate.  Inflation is inching its way higher. And the Fed remains on track for three rate hikes this year which would bring the yearend funds rate to 1.25%.

The economy may deviate from our expectation as the year progresses but, for now at least, the moderate growth scenario remains intact.

Stephen Slifer


Charleston, S.C.

Fulfilling Expectations

April 14, 2017

There can be little doubt that expectations about President Trump’s proposed policy changes are influencing individual and business attitudes.  It is evident in the stock market which remains close to a record high level.  It can be seen in measures of consumer confidence and indicators of business confidence.  But are rising expectations based solely on hoped for policy changes?  We do not think so.  Our sense is that the economy will experience slightly faster GDP growth this year even if none of President Trump’s policy changes are enacted.  Our hope is that many of his policy changes will be adopted (to some degree) which will further stimulate near-term GDP growth and, simultaneously, boost the economy’s long-run potential growth rate from 1.8% today to 2.8% by the end of the decade.

Rising investor expectations can be seen in the stock market which is within 2.0% of its record high level.

Consumer confidence measures are at their highest levels thus far in the business cycle.

With respect to rising consumer confidence, the University of Michigan’s Chief Economist, Richard Curtin, had an interesting observation.   The University of Michigan apparently tracks its survey responses by political affiliation so they can compare the attitudes of Republicans versus Democrats.

There was no discernable different between the two groups with respect to current conditions.  Indeed, the current conditions component at 115.2 is at its highest level since 2000 and partisanship had no particular impact with little difference between Republicans and Democrats.

That was not the case with the expectations component.  Expectations amongst Democrats were 64 in April which is consistent with a deep recession.  Expectations amongst Republicans were at 115 which is generally associated with robust economic activity.  That is an astonishing difference of more than 50 points.

As evidenced by the rise in the overall expectations index, the majority of consumers have a sense that President Trump will produce meaningful cuts in individual and corporate income tax rates, regulatory relief for businesses, and some repatriation of corporate earnings.  That will, presumably, boost GDP growth for both 2017 and the years beyond.  But because a significant number of consumers do not share that enthusiasm, it will be difficult to envision a significant upswing in consumer spending and GDP growth until these divergent views converge.  Given the apparent lack of progress on policy issues in Washington It seems likely that this gap will remain wide for months to come.

Businesses in America are equally upbeat.  For example, the Institute for Supply Management’s report on business conditions indicates that corporate sentiment amongst manufacturing firms has climbed to its highest level in two years and is within a couple of points of being the highest level in a decade.  Sentiment amongst non-manufacturing firms has climbed appreciably.  Small business confidence has already surged to its highest level since 2004.

One might be tempted to dismiss the stock market gains since the election and these big increases in consumer and business confidence as merely indicators of hoped for policy changes and if President Trump cannot pass legislation to implement them the economy will weaken noticeably.

But be careful.

Firms are seeing significant increases in their order books.  Orders do not rise solely based on expectations.

These firms indicate they are boosting employment to presumably help them increase production to satisfy the demand associated with the additional orders.  Employment does not rise based solely on expectations.

Furthermore, since the election numerous companies have announced an intent to boost hiring in the U.S., shift overseas production back to the United States, and/or boost investment.  The list is long and includes such firms as Amazon, Walmart, General Motors, Ford, Hyundai, Sprint, Pizza Hut, Bayer, and even the Chinese retail giant Alibaba.  While the exact magnitude and timing of the additional hiring and investment remains uncertain, the reality is that something fundamental has changed since the election which will boost GDP growth completely apart from a mere hope that Trump’s policy changes will bring about change.

Meanwhile, prices are on the rise.  In late 2014 and 2015 falling prices, particularly in the oil sector, led to a sharp contraction in both current spending and investment in that sector.  But oil prices have rebounded.  Drillers are re-opening previously shuttered oil rigs.  The drag on GDP growth from the oil sector has ended and it is now providing a moderate amount of stimulus for the economy.

GDP growth in 2016 was 2.0%.  Even without policy changes from President Trump and Congress, we would expect GDP growth for 2017 to edge upwards to 2.2% given the factors cited above.  If some of the hoped for policy changes can be enacted (even a watered down version), GDP growth this year should accelerate further to 2.4%.  But the most significant impact will probably be on GDP growth in the years ahead.

Trump’s policy changes will significantly stimulate investment spending which will, in turn, boost productivity growth which has slipped in recent years to about 0%.  Because productivity growth is one of the determinants of the economy’s “potential” growth rate, faster growth in productivity should boost our economic speed limit from 1.8% or so today to 2.8% by the end of the decade.

The bottom line is that the economy is gathering some momentum with or without help from President Trump.

Stephen Slifer


Charleston, S.C.

The Fed Reveals its Game Plan

April 7, 2016

The Federal Reserve has been gradually raising the federal funds rate since December 2015. That rate has climbed from near 0% to 0.75%. It needs to climb to about the 3.0% mark for short-term interest rates to be regarded as “neutral”. Thus far, the Fed has done nothing to address the massive overabundance of excess reserves in the banking system. These surplus reserves matter because they represent the ability of the banking system to make loans to consumers and businesses. Now that the economy is showing signs of accelerating the Fed cannot afford to ignore these surplus reserves for much longer. It is well aware of the problem and has outlined a game plan to address the issue.

In the minutes of the most recent meeting of its Federal Open Market Committee the Fed indicated that it would most likely raise the funds rate another two times between now and the end of the year. That would boost the funds rate to 1.25% which still leaves it far below the so-called “neutral” level of 3.0%. The Fed then plans to take a break from raising short-term interest rates and turn its attention to the reserves issue.

By yearend it will begin to eliminate excess reserves in the banking system. As part of its easing initiative in the wake of the recession the Fed embarked on an unprecedented bond buying program. It purchased U.S. Treasury bonds and mortgage-backed securities from banks and put the proceeds from those transactions into a bank’s checking account at the Fed which is known as a “reserves” account. In the process the Fed’s balance sheet exploded as did the volume of surplus reserves in the banking system.

Before the Fed embarked on its bond buying program excess reserves were $2.0 billion. They have since climbed a thousand-fold to more than $2.0 trillion. Thus far those funds have been sitting idle in commercial bank accounts at the Fed. Banks have been unwilling or perhaps unable to lend those funds to consumers and businesses. As long as those funds remain at the Fed the economy receives no stimulus. But if banks suddenly become more willing and/or able to lend, those reserves could fuel a spending spree the likes of which we have never experienced. Hence, the Fed eventually needs to eliminate those excess reserves.

But when should the Fed begin? And how should it proceed? The Fed recently provided guidance.

One option would be for the Fed to sell securities to banks in the same way that it bought those securities earlier. But to do that the Fed would need to enter the market via its open market operations and announce to the world what it is doing. It is a very visible action and sends an implicit message that it is aggressively trying to slow the pace of economic activity. That is not the Fed’s intention. Rather, it wants to eliminate those reserves in a more subtle manner.

A second option for the Fed would be to hold U.S. Treasury bonds and mortgage-backed securities to maturity, and then not replace them. Like an outright sale this option would, over time, eliminate the surplus reserves in the banking system without sending a message to the world that it was aggressively tightening its monetary policy stance. But because the average duration of the Fed’s portfolio is about six years, if it chooses this option it would take years for all surplus reserves to be eliminated.

If the Fed were to raise the funds rate and simultaneously allow long-term securities to mature it would, effectively, be doing two forms of tightening at the same time – raising both short-term and long-term interest rates — which could jeopardize the expansion. Thus, the Fed has indicated its intention to raise the funds rate twice more this year, but then stop raising rates for a while as it allows some of its bond holdings to mature. It will probably choose that second option for most of next year.

The bottom line is that the Fed has begun the process of reversing its wildly accommodative monetary policy stance by returning interest rates to a more normal level and gradually shrinking its balance sheet to eliminate the volume of surplus reserves in the banking system. The days of ultra-easy monetary policy have come to an end. But the Fed is well aware that it cannot move too aggressively without endangering the pace of economic activity. As long as the inflation rate climbs slowly it can afford to proceed at a leisurely pace — raising short-term interest rates for a while, then allowing some of its bond holdings to mature. Given a snail’s pace of removing excessive monetary policy accommodation, it is hard to envision Fed policy threatening the economy any time soon.

Look for the economy to grow at a steady pace for years to come and ultimately produce a record-breaking period of expansion.

Stephen Slifer
Charleston, S.C.

Revising Our Thinking about Education

March 31, 2017

Technology has changed the world and the rate of change is accelerating.  Many factory jobs have disappeared as humans have been replaced by robots.  The factory jobs that remain require computer and writing skills that were unnecessary 20 years ago.  High school graduates need not apply.  As a result, there is a huge skills gap between what today’s manufacturing firms require, and what our 4-year colleges and universities are currently able to produce.  Increasingly, manufacturing firms are working with 2-year community colleges to develop programs tailored specifically to their needs.  Students graduate with a degree, a job, and no debt!

Factory employment reached a peak of nearly 20,000 jobs in 1979.  It declined gradually for the next 20 years but was still substantial at slightly more than 17,000 in 2000.  In the past 17 years, however, it has fallen 30% to about 12,000.

Temp -- Factory employment

In that same period of time factory production has increased 8%.  Manufacturing firms are producing more goods with fewer workers.  A study done at Ball State University estimates that 90% of the factory jobs that have disappeared since 2000 were lost to innovation — not to workers in other countries.  But before you lament that job loss too much, consider the fact that any job that can be replaced by a robot is not a very good job in the first place.

Temp -- Factory Production

So what’s next?  The service sector.  It does not take too much imagination to conjure up a whole variety of service sector jobs that could be automated.  Think about bank tellers (which have already largely disappeared), lawyers and their mind-numbing search for precedents and indecipherable legal lingo, accountants and bookkeepers, investment bankers, doctors analyzing test results and generating reams of paperwork, and even (gasp!) economists.

The jobs that remain will require workers to be computer savvy, write intelligent reports and analysis and solve problems on the fly.  Many high school graduates, unfortunately, are unable to pass the reading, writing, and math screening tests required by today’s employers.

Our colleges and universities can help.  Unfortunately, many such institutions continue to promote their liberal arts curriculums.  The faculty is focused on the promotion ladder and attaining tenure.  They are slow to adapt to the changing needs of today’s labor market.  In our opinion, our nation’s colleges and universities should downsize their liberal arts programs and ramp up opportunities in science, technology, engineering and math.

To fill the skills gap quickly many manufacturing firms have formed partnerships with a local community college to devise programs tailored to their specific needs.  In the Charleston area firms like Boeing, Bosch, Mercedes, and the new Volvo plant are working with Trident Tech to do just that.  And Charleston is not unique.  In many cases the company will provide a scholarship to the community college.  The students will work at the company to satisfy some of the academic requirements.  And the student will be guaranteed a job upon graduation.  They get a degree, acquire job skills, and graduate with no debt.    How cool is that?  Furthermore, these are good paying jobs with about 40% paying more than $50,000 which make them comparable to the pay earned by students graduating with bachelor’s degrees.

The problem is convincing students and their parents to consider these apprenticeship programs.  The path to fame and fortune is still generally believed to be through a bachelor’s degree.  Apprenticeship programs in the U.S. have for decades been associated with high school underachievers and jobs in the construction industry.  That is no longer true.  Firms offering these apprenticeship programs require computer and math skills, writing ability, and problem solving abilities that are definitely not for underachievers.

Europe has always offered a two-track path for professional success.  Upon graduation from high school the student chooses either an academic path and goes on to university, or opts for an apprenticeship.  It is not uncommon for corporate executives to get their start in apprenticeships.  It is a very accepted path for advancement in professions as diverse as health care, banking, retail trade, and the hospitality industry.

In the U.S., in our opinion, we should be sending fewer students to four-year colleges and universities, and encourage more of them to consider a vocational tract at the local community college.

Stephen Slifer


Charleston, S.C.

Politics May Alter the Economic Landscape

March 24, 2017

The economic data are encouraging.  In the U.S. consumers, business leaders, and investors are hopeful that the Trump administration will be able to reform health care, cut individual and corporate income tax rates, and provide regulatory relief.  As this column is being written the Trump/Paul Ryan health care plan appears to be at risk.  Even if it manages to get through the House, passage in the Senate will be even more problematical.  As this drama unfolds it is likely that currently lofty expectations will soon bump into reality.  The pendulum may swing in the opposite direction for a while.  But that is OK.  Neither the stock market nor the economy move in a straight line.  Zigs and zags are the norm.

We continue to believe that ultimately legislation will pass that produces meaningful change in health care, taxes, and regulatory relief, although we also believe that the final product will be less dramatic than expected.  We continue to expect GDP growth this year of 2.4% and 2.7% in 2018.  We have explicitly boosted this year’s growth rate by 0.1% and 2018 growth by 0.3% to reflect the likely impact of these legislative initiatives.  If the process bogs down or fails to pass we will have to ratchet down our expectations.  Thus, we readily acknowledge that politics will have a meaningful impact on our U.S. GDP forecast for the next several years.  But no not expect success or failure on any one piece of the package to significantly alter that expectation.  It will be a protracted process.

While keeping one eye on political developments in the United States keep your other eye focused on political developments in Europe, France in particular.  The first round of the presidential election will occur on April 23.  There are currently 11 candidates in the running.  If no one candidate gathers 50% of the vote, which seems likely, there will be a run-off election between the top two candidates on May 7.

The French election is of particular interest to Americans because of the rise in the polls of Marine Le Pen the leader of France’s National Front.  She calls for exiting the European Union, is anti-immigration, and wants to introduce tariffs as part of protectionist economic policies to put “France First”.  With GDP growth that is typically less than Germany, a 10.0% unemployment rate, a 24% youth unemployment rate, the highest taxes in the developed world, and terrorist activity on the rise, she has considerable appeal amongst disaffected working class voters in the rust-belt regions of France who feel they are being left behind and in areas with high levels of immigration.

At the moment she is running neck-and-neck in the polls with Emmanuel Macron.  They are expected to be the top two vote getters in the April 23 election.  But those same polls suggest that Macron will win in the runoff with a victory margin of 2:1 versus Le Pen.  However, pollsters’ credibility has been impugned in the past year given their failure to predict either the Brexit vote in June or the Trump victory in November.  Understandably, Europeans along with the rest of the world, are watching political developments in France closely.  A French exit would be the death knell for the European Union and send shock waves around the globe.

But suppose that Macron becomes the next President of France.  He is 39 years old and never held elected office.  He stands as an independent because he created his own party.  How effective will he be as a leader?

Either outcome is disquieting.  A Le Pen victory would likely signal a breakup of the European Union.  A Macron victory might be somewhat more comforting initially, but because an imminent breakup of the E.U. would be off the table for now the Euro is likely to rise.  A significant increase in the Euro would make European goods and services more expensive for Americans and Asians to purchase, reduce growth in exports, and act as a brake on European GDP growth which is just now emerging from the doldrums.

Our hope is that Macron wins and that E.U. officials take advantage of the apparent acceleration of GDP growth to find ways to diversify growth, strengthen the structure of the European Union, and introduce legislation liberalizing the excessive regulation of the labor market.  Failure to do so will only encourage the populist movement in the years ahead.

We are far more comfortable analyzing economic events around the globe but now, more so than usual, political events are likely to dominate the economic landscape.

Stephen Slifer


Charleston, S.C.

Oil Prices Should Continue to Slide

March 17, 2017

On March 7 oil market participants suddenly realized that that oil inventories had reached a record high level.  Almost overnight oil prices fell by $5.00 per barrel.  Our sense is that the $55 price in late February will probably turn out to be the high price for the year.  Why?  Because at that level U.S. producers turned on the spigot.  As supply began to rise inventories also began to climb.  That, ultimately, caused prices to fall.  A dramatic change in the oil market in the past seven years appears to have put an effective cap on oil prices at about $55 per barrel.

Gasoline Prices -- Crude

Since the turn of the decade technological developments in the oil market like hydraulic fracturing and horizontal drilling have allowed oil drillers to profitably pump oil from previously inaccessible locations.  As a result, U.S. oil production has essentially doubled during that period of time.  The oil industry has been turned topsy-turvy by these technological advancements which have dramatically and permanently increased the global supply of oil.

Gasoline Prices -- Production

As U.S. output surged by early 2015 inventory levels climbed to what were then record high levels.

Gasoline Prices -- Inventory Levels

Eventually prices fell from a high of $107 in late 2014 to a low point of about $28 per barrel.

Gasoline Prices -- Crude Monthly

As oil prices declined drillers found that many of their existing rigs could not be operated profitably and in 18 months they shut down 80% of the rigs that had been in operation in October 2014 when oil prices began to collapse.

Gasoline Prices -- Oil Rif Count

While the number of rigs in operation fell 80% oil production dipped by only about 12%.  How can that be?  Easy.  Oil producers became much more efficient and output per rig climbed from about 800 million barrels per day prior to the introduction of this new technology to 4,500 million barrels daily (the blue bars in the chart below).  To put that in slightly different terms, the oil drillers marginal cost of production fell from about $80 per barrel prior to the introduction of this new technology to about $45 per barrel currently – and their efficiency continues to climb by about 30% annually which implies even lower costs of production in the years ahead.

Gasoline Prices -- Productivity

Upon reaching a low point of $28 per barrel oil in the middle of last year prices have rebounded to about $55 per barrel.  Suddenly drillers found that they can once again produce oil profitably.  The number of rigs in operation has increased from a low point of 404 thousand to 789 thousand.

Gasoline Prices -- Oil Rif Count

And as the number of operating rigs has climbed oil production is back to within 5% of its previous peak.

Gasoline Prices -- Production

But that creates a problem.  A pickup in production of that magnitude has created a situation where oil inventories in the U.S. have surged to an even higher record level.

Gasoline Prices -- Inventory Levels

Given this backdrop it is perhaps not too surprising that prices have, once again, begun to fall.

Gasoline Prices -- Crude

Going forward it is likely that prices will dip further in the months ahead until such time as U.S. producers cut back production which may not occur until prices dip to $45 per barrel or even lower.  Furthermore, the peak driving season occurs right around the July 4th holiday and both crude oil and gasoline prices tend to peak at that time of year and then decline between July and December.

OPEC countries agreed to cut back production in December, but despite the cut in OPEC output U.S. production has surged and countered the OPEC decline.  As a result, inventory levels in the U.S. and around the globe have continued to climb.  That is not a sustainable situation. Production must shrink so that oil stocks drop back into closer alignment with demand.  Our sense is that prices will continue to slide until the pain gets so great that producers will ultimately be forced to slash production.  What we do not know is when that process will begin.  $45? $40?  $35?  $30?

What all this seems to mean is that the oil market today is vastly different from what it was just a few short years ago.  Instead of crude oil trading in a range from $80-110 per barrel, the new range seems to be somewhere between $30-60 per barrel.  U.S. production has change the entire industry.  And that is a good thing.

Stephen Slifer


Charleston, S.C.

Gathering Momentum

March 10, 2017

Since the election in early November the economy has shifted in a fundamental way.  Consumers, businesses and investors are the most optimistic they have been in years.  The stock market is on a roll and reaches a new record high level every few days.  Consumer confidence has surged.  Business spirits are soaring.  That newfound optimism is translating into jobs.  Given the timing of these dramatic changes it is evident that the source of this newfound enthusiasm is the election of Donald Trump.  Given that legislation cutting individual and corporate income taxes has not yet been introduced, and that the regulatory burden remains largely unchanged, it may be that the current degree of optimism is overstated.  Setbacks will undoubtedly occur as the year progresses, but there can be little doubt that the economy is gathering momentum, inflation is on the rise, and the Fed’s near-0% interest rate policy is a thing of the past.  What has yet to be determined is the extent of that improvement.  We believe the acceleration in GDP growth this year will be moderate, the core inflation rate will climb and rise a bit above the Fed’s 2.0% target, and the Fed will adhere to the 3-rate-hike plan it has previously suggested.

The stock market continues its ascent.

S&P 500 Stock Prices -- Short

That increase in the stock market is important because it is boosting consumer net worth.  During the course of the past year net worth climbed 6.3%, but in the two most recent quarters the stock market gain has boosted growth in net worth to a 9.2% pace.

Consumer Net Worth

Given the increase in net worth and the prospect of cuts in individual income tax rates later this year it is no wonder consumer confidence has risen to its highest level in a decade.

Consumer Confidence

Business confidence amongst manufacturing firms has risen almost 10 points in the past year.  In December 2015 this index stood at 48.0.  The manufacturing sector was in a slump and contracted for five consecutive months.  In February of this year the index stood at 57.7 with 17 of 18 manufacturing industries reporting growth in that month.  Orders are surging.  Production is picking up.  Employment is rising.  The turnaround is being fueled by the likelihood of reductions in the corporate tax rate later this year, and relief from the currently punishing regulatory environment.  The Institute for Supply Management believes the February level of the index is consistent with GDP growth of 4.5%.  While GDP will not rise that rapidly this year, there is no doubt that the manufacturing sector is on the mend.


Firms in the service sector are experiencing similar improvement and the ISM service-sector index has reached its highest level in more than two years.

NAPM -- Nonmfg.

As business sentiment has rebounded, so has hiring.  Private sector employment rose 224 thousand per month in the first two months of the year.  That compares to an average monthly gain of 170 thousand in 2016.   Employment in the service sector has been rising steadily for the past couple of years while the production sector – manufacturing, construction, and mining – was steadily contracting.  But now employment in those industries has begun to turn upwards.

Factory employment was hit by the 20% increase in the value of the dollar from mid-2014 through the early part of last year which caused adversely impacted growth in U.S. exports.

Trade-weighted dollar

As a result, factory employment fell for more than a year.  But in the past three months jobs in the manufacturing sector have risen by 19 thousand per month.

Payroll Employment -- Manufacturing

Employment in mining was clobbered by the decline in oil prices.  But oil prices have rebounded and mining employment has climbed back into positive territory.

Payroll Employment -- Mining

In the construction industry an extreme shortage of both single-family and residential housing and strength in commercial real estate have generated strong demand for construction workers.  However, builders have been constrained in their ability to hire because they have been unable to find an adequate supply of qualified workers.  Even so, construction employment has averaged about 25 thousand per month for a while.  The pickup in construction employment in January and February largely reflects the unusually mild winter weather and undoubtedly overstates the case, but employment gains in the industry appear to be on the rise.

Payroll Employment -- Construction

After several years of disappointing GDP growth it is encouraging to see so many leading economic indicators showing signs of life.  The exact dimensions of the upturn may be unclear, but the direction is not.  Look for the Fed to raise the federal funds rate to 0.75% at its meeting next week.


Stephen Slifer


Charleston, S.C.

Next Fed Rate Hike – March 15

March 3, 2017

Fed officials have hinted that the first of the Fed’s three expected rate hikes this year will occur on March 15.  That will undoubtedly encourage speculation that the Fed will raise the funds rate more than three times this year.  We are not yet prepared to go there.  It appears to us that GDP growth will accelerate somewhat this year and inflation should rise gradually.  If so, there is no compelling reason for the Fed to alter its basic game plan – three rate hikes this year followed by additional slow but steady increases in the funds rate in 2018 and 2019.

The sooner-than-expected rate hike has been influenced by a variety of factors.  First is the stock market.  It has risen 14% since the election.  Some argue that the stock market is overvalued.  But before one goes too far down that road keep in mind that the stock market reflects a discounted stream of future earnings.  If one believes that tax cuts, regulatory relief, and a resurgence of infrastructure spending are forthcoming, corporate earnings are likely to grow at a double-digit rate this year.  We believe that the S&P 500 index will continue to climb as the year progresses – but not necessarily in a straight line.

S&P 500 Stock Prices

Second, President Trump’s speech to the joint session of Congress was the most presidential of his short tenure in office.  The policies he advocates are the same ones he pushed during the campaign, but the tone was different.  In contrast to his other speeches he urged the American people and members of both parties to come together for the good of the country.  The possibility that our president can actually be presidential was highly encouraging.  He still must get Republicans and Democrats on board to implement policy changes and that will not be easy, but the change in tone was encouraging.

Third, in his speech President Trump said, “Since my election, Ford, Fiat-Chrysler, General Motors, Spring, Softbank, Lockheed, Intel, Walmart and many others have announced that they will invest billions and billions of dollars in the United States, and will create tens of thousands of new American jobs.”  Many of those pledges were almost certainly done to appease President Trump and ensure that he did not direct an angry tweet in their direction.  And some of that spending and many jobs may never materialize.  But it is hard to deny that something is happening that will boost investment spending, stimulate GDP growth, and create more jobs.

Fourth, business confidence is soaring  The Institute for Supply Management (ISM) index for manufacturing firms has risen in each of the past six months and now stands at 57.7.  That is the highest reading in more than two and one-half years.  These firms are seeing their order books rise, they intend to keep hiring for the foreseeable future, the backlog of orders has begun to rise, and virtually every firm has seen prices rising.  The index for non-manufacturing firms (which covers almost 90% of the economy) looks similar.   The ISM indicates that current levels for these two indexes are consistent with GDP growth of 3.5-4.0%. Something is happening.

NAPM -- Mfg . vs. Nonmfg.

Fifth, respondents to the ISM survey report that prices have risen in recent months and it reflects increases in commodity prices across the board.  Energy prices have climbed.  But so have non-energy commodity prices including agricultural raw materials, food, industrial metals, and industrial materials.  Something is happening.

Commodity Prices -- Energy versus Nonfuel

Sixth, the labor market continues to tighten.  Initial unemployment claims – a measure of layoffs – has fallen to 223 thousand which is the lowest level since April 1973 — 44 years ago!  Something is happening.

Initial Unemployment Claims

From the Fed’s viewpoint these developments provide assurance that the economy is truly gathering momentum.  The days of anemic 2.0% GDP growth are over.  The days when inflation was near 0% and a whiff of deflation was in the air are over.  The downside risk to economic growth has largely disappeared.  The time for 0% interest rates has come to an end.  The Fed recognizes this and has announced its intention to gradually raise the funds rate until it eventually reaches its so-called “neutral” level of about 3% by 2020.

We expect GDP growth to pick up gradually this year to 2.4% from 2.0% in 2016 and the core CPI to increase to 2.5% this year from 1.9%.  Those projections are roughly in line with what the Fed expects.  But in view of the developments described above, it is possible that the economy could expand more rapidly this year and inflation could be higher than expected.  If things turn out to be surprisingly strong it is prudent for the Fed to take advantage of the current positive economic environment and make its first rate hike of the year now.

Stephen Slifer


Charleston, SC

The Topsy-Turvy World is Returning to Normal

February 24, 2016

Since the U.S. presidential election in November economic optimism has picked up around the globe.  It is most evident in the United States, but stock markets in the United Kingdom, Europe, and Japan have all risen sharply.  Inflation has begun to climb.  Interest rates are headed higher.  Why?  Donald Trump.  Love him or loathe him, Trump’s proposals to sharply cut individual and corporate tax rates, relieve the regulatory burden on corporate America, and allow U.S. businesses to repatriate earnings at a favorable tax rate, have boosted confidence and energized stock markets from New York to Tokyo.  It is becoming increasingly evident that the protracted period of ultra-easy monetary policy around the globe is coming to an end.

In the United States the S&P 500 stock index has climbed 13% since the election and now stands at a record high level.

temp--stock prices

The tax cut/regulatory relief/repatriation of earnings combo has also lifted corporate spirits.  The YPO (formerly called the Young Presidents’ Organization) does a quarterly survey of business confidence amongst its 24,000 member CEO’s in 130 countries.  It then publishes confidence readings for nine regions around the globe.  In January confidence amongst members in the U.S. jumped 4.2 points to 64.6.  But global confidence also rose 3.0 points in January.  Confidence climbed in virtually every region – Asia, Australasia, Canada, the E.U., non-E.U. Europe, Latin America, and the Middle East/North Africa.   Animal spirits are re-emerging around the world.  And it is fairly clear that the catalyst for these changes was the election of President Trump.

temp--stock prices


The hope is that President Trump’s policies will ignite a long-awaited rebound in investment spending in the U.S.  Consumer spending will get a boost from the expected cuts in individual tax rates.  Government spending is likely to climb as defense spending gets a boost.  However, the stock markets and confidence today are probably inflated by overly optimistic expectations with respect to the magnitude and timing of the various fiscal stimulus measures.  At some point investors will hit a speed bump and the stock market will experience a correction.  Confidence levels will encounter a dose of reality.  But that is perfectly acceptable and should be expected.  The reality is that something good is going to happen.  Our forecast for GDP growth of 2.3% this year and 2.6% in 2018 assumes only a moderate amount of stimulus from Trump’s proposed policy changes.

Given that the U.S. is the world’s largest economy it is not surprising that a rosier U.S. outlook is going to have spillover effects elsewhere.  In Europe the Euro Stoxx 50 has climbed 13% since the U.S. election.

temp--stock prices

While stock investors have gotten caught up in the euphoria, confidence amongst YPO members in the E.U. gained 0.2 point in January to 60.9, the smallest increase amongst the nine regions surveyed.  Presumably these corporate leaders are wary given that three important elections will take place on the continent later this year and sentiment is shifting in the favor of the Euroskeptics and political parties with a populist appeal.  The risk is that an unanticipated election result could upset the current equilibrium and raise questions about the viability of the European Union.  While such an outcome still seems to be a relatively low probability bet, the reality is that pollsters have been dead wrong in anticipating the outcome of the Brexit vote in the U.K. in June of last year and Donald Trump’s election as president of the U.S. in November.

temp--stock prices


In France the hotly-contested presidential election will occur in April 23 with a run-off on May 7.   Far-right candidate Marine Le Pen leads in the first round of voting but is expected to lose in the runoff.  She calls for exiting the E.U., stopping free movement at the French border, and introducing tariffs as part of protectionist economic policies to put “France First”.

German Chancellor Angela Merkel has come under fire for her handling of the refugee crisis and her approval rating has steadily declined.  She is being challenged by the AfD (Alternative for Germany) a right-wing, anti-immigrant party whose support has been rising.

Italy’s Prime Minister Renzi lost a vote in December on constitutional reforms and resigned.  The loss was viewed as stinging defeat for the political establishment and a significant boost for the country’s surging populist movement just weeks after President Trump’s election in the U.S.

Confidence amongst YPO leaders in Asia rose 1.2 points to 61.2 in January.  But Asia includes China, Japan, India, and many emerging economies. Confidence amongst those countries often moves in different directions.

temp--stock prices


The Japanese stock market has risen 14% since the U.S. election.

temp--stock prices

Confidence amongst corporate executives in Japan rose 3.2 points in January.  This heightened optimism is largely the result of the depreciation of the yen combined with ultra-easy monetary policy.

temp--stock prices

China’s GDP outlook has changed very little in recent months.  However, Chinese officials are seriously concerned about Trump’s review of the “One China” policy that has been the cornerstone of China/U.S. relations for more than 40 years.  The relationship between the two countries has grown increasingly tense as Trump has indicated a willingness to impose 35% tariffs on some Chinese goods being exported to the United States.  At the same time, Trump has branded China as a currency manipulator as the yuan has depreciated by about 15% since reaching a peak of about 6.0 yuan to the dollar in January 2014.  Thus, the greatest danger to the Chinese economy in 2017 is probably political risk tied to its relationship to the U.S.

temp--stock prices

While confidence changes in the largest Asian countries were relatively modest, that was not the case for the emerging/developing ASEAN countries which include Indonesia, Malaysia, Singapore, Thailand, Philippines and Vietnam amongst others.  Confidence jumped 9.4 points in January to 62.0 which seems to reflect rising commodity prices – oil in particular.  The OPEC decision in late November to curtail output that caused the price of Brent crude oil to jump $10 per barrel from $45 to $55 was of particular help to Indonesia and Malaysia.

temp--stock prices

Expected changes in fiscal policy have justifiably rekindled animal spirits in the U.S.  GDP growth is clearly accelerating.  As oil prices in particular and commodity prices in general have rebounded, inflation has picked up and is very close to the Fed’s target.  The Federal Reserve has begun to lift short-term interest rates.  These same developments are occurring in Europe and Asia but to a lesser degree.  It is becoming increasingly evident that the protracted period of ultra-easy monetary policy around the globe is coming to an end.  The topsy-turvy world is returning to normal.

Stephen Slifer


Charleston, S.C.