Clients have asked whether they should continue to be bullish on the U.S. economy and equities when the media continues to emphasize a plethora of troubling issues including a flat lining manufacturing sector, an energy sector that is still contracting, and a new host of government taxes and regulations (from federal, state, and local authorities) that make it difficult for small businesses to remain viable. The purpose here is to assess those issues and put them into proper perspective.
Anyone who has paid any attention to business headlines knows that the oil industry continues to struggle. And now that the Obama Administration has made its deal with Iran, a significant additional supply of oil will come to market by year’s end (unless Saudi Arabia cuts their production – unlikely). In addition, the Index of Industrial Production has been flat since last September, and capacity utilization is down nearly 2% since November. If it weren’t for the boom in the auto industry, this index would likely be much lower.
The weakness in manufacturing is a direct result of the rapid rise in the value of the dollar vis a vis other major currencies. As the value of the dollar rises, the U.S. trade balance deteriorates (fewer exports – mainly manufactured goods, more imports). The adoption of money printing and low interest rate policies by most other major central banks, while, at the same time, the Fed prepares to raise rates in the U.S., only exacerbates the dollar and manufacturing issues. Plus, weak foreign economies naturally demand fewer U.S. exports. I suspect that the ISM Manufacturing Index for July (release date: August 3) will not show much strength. Nor will July’s Industrial Production Index (release date: mid-August). And, the media will act as if a recession is approaching.
Besides the oil and manufacturing stories, in its mid-July report, the optimism index of the NFIB (National Federation of Independent Businesses – an association catering to small and medium sized businesses) took a huge 4.2 point plunge for its June reading, no doubt due to the plethora of new regulations passed by the various state and local governments including large increases in the minimum wage, continuing increases in benefit costs, higher taxes, and new interpretations and regulations promulgated by the Labor Department and other agencies. The Employment Cost Index is up more than 5% year over year, and, as a result, as reported in the Wall Street Journal (June 12), rising employment costs may cause businesses to rethink how they allocate staff, which could negatively impact the labor market going forward. Their press release concludes:
The government “continues to push regulation to compel firms to pay people more (minimum wage, overtime, ‘share the wealth,’ health care, sick leave), but does not ask them to produce more to justify the higher pay…”
Let’s put all of this into perspective. The first fact to recognize is that while the U.S. was once the bastion of manufacturing activity (auto, furniture, clothing…), it gave that up over the years to lower wage and benefit countries and became a “services” economy. (Does anyone remember the 1992 Presidential debates and H. Ross Perot’s “giant sucking sound” remark – referring to his belief that U.S. manufacturing jobs would go to Mexico if NAFTA (North American Free Trade Agreement) went into effect?) Today, manufacturing represents only about 12% of the U.S. GDP, and the oil industry only about 2.5%. So, while these are surely drags on economic activity, if the rest of the economy is doing well, economic growth still occurs.
The typical post-WWII recovery is led by autos, housing, and financials. The Great Recession ended nearly 6 years ago. But, these three sectors are just now taking off, indicating that the real (typical) recovery has just begun. (Auto sales averaging more than 17 million units at an annual rate over the past 4 months; housing starts up 9.8%; building permits up 7.4% – best since ’07; the National Association of Home Builder’s Index at a cycle high in both June and July.) The Fed’s Flow of Funds report for Q1 showed a much healthier consumer with debt/asset and debt/equity ratios at 15 year lows, the consumer’s ability to service debt the best it has been since the ‘80s, and home equity on consumer balance sheets the best since ’06.
To corroborate a stronger consumer, look at the Q2 earnings reports of the major banks. For example, Citi reported an 11% growth in retail lending, and Wells a 15% increase in credit card receivables. The Fed’s Beige Book (which is a summary of comments from U.S. businesses) was released on July 15th for the period mid-May to the end of June. It showed:
- Increasing Real estate construction activity, both commercial and residential;
- Rising home sales and prices;
- Strong growth in employment with labor markets tight where specialized skills are needed;
- Growth in nonfinancial businesses, professional, and healthcare services;
- But, uneven activity in manufacturing and energy due to dollar strength and issues in oil and gas.
From all of this, it is clear that the consumer is spending and has the capacity to continue to spend. There are some clouds forming on the horizon, especially the disincentives caused by higher employment costs, taxes, and additional business regulation. But, the real economic recovery has just begun (led by housing, autos and financials). As for those clouds that are still forming – something to worry about, but not imminent. Yes, manufacturing (12% of the GDP) will continue to struggle as long as the rest of the world is weak and continues the currency wars. And the energy industry will continue to be plagued by over supply and lower prices– not good for 2.5% of the economy, but great for the other 97.5%.
Robert Barone (Ph.D., Economics, Georgetown University), an advisor representative of Concert Wealth Management, Inc., is a Principal of Universal Value Advisors (UVA), Reno, NV, a business entity. Advisory services are offered through Concert Wealth Management, Inc., a Registered Investment Advisor. Dr. Barone is available to discuss client investment needs. Call him at (775) 284-7778.
Statistics and other information have been compiled from various sources that Universal Value Advisors believes to be accurate and credible but makes no guarantee to their complete accuracy. A more detailed description of Concert Wealth Management, Inc., its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.