Economic Notes for the Week of August 13th

A lighter economic week to some extent—at least compared to last week.

Consumer credit growth slowed in June, to $6.46 billion, which is about half of what was expected by analysts.  This can be a tricky measure, though, as slowing credit may mean less spending (due to Americans’ tendency to use credit cards extensively), or may mean income is growing and we don’t need the credit as much).  The ‘non-revolving’ credit (non credit card) piece increased by a large amount, mainly due to government student loans.

Non-farm productivity for Q2 showed a gain of +1.6%, which was a few tenths of a percent better than forecast.  Unit labor costs for the quarter also rose +1.7%, which was quite a bit higher than the expected +0.5%—the year-over year trend remains at +0.8%, which is in line with generally low inflation currently.

The international trade deficit narrowed by $5.1 billion to $42.9 billion in June, which is the tightest amount in almost two years and significantly better than forecast.  Much of this stemmed from lower energy prices, which explains some of the import side, but appears our exports have picked up some of the slack—this is a positive sign.  This figure is also affected by the strength/weakness in the U.S. dollar versus our key trading partners, like Europe, Japan and increasingly, China.

Wholesale inventory accumulation in June was about a half-percent weaker than expected at -0.2% and the May figures were revised down.  This was largely in line with other data.  Import prices fell in July a bit by -0.6% due to lower commodity prices (mostly petroleum), which countered expectations for a small gain.

Initial jobless claims came in at a lower 361k for the Aug. 4 week, which was a bit less than the 370k forecast.  Free from seasonal distortions like summertime auto plant shutdowns, this is a positive below-trend development, albeit for only a week.  Continuing claims came in at 3,332k for the Jul. 28 week, which was about 53k higher than forecast.

Don’t expect a lot from Europe in August—that’s when the entire continent takes to ‘holiday.’  (We say that tongue-in-cheek, but not completely.)  A few thoughts came to mind recently.

While the situation and numbers look terrible (lack of GDP growth and high debt), this story is the same one as the ongoing saga we’ve been facing for, well, now years.  It would be more helpful if there were something new to tell clients, at least.

Spain’s problems are a similar to a mix of what’s been experienced by Ireland and Greece, only larger.  Like Ireland (and the U.S. to some extent), the real estate overbuilding boom that ended up in a burst bubble left a mess on bank balance sheets and consumer finances.  This isn’t unlike other banking crises in the past, where the fundamental building blocks of assets-to-liabilities broke down.  As it’s a tangible asset, we can at least put a finger on real estate and get a general idea of where we stand.

Like Greece, however, the excesses in parts of Southern Europe were perhaps accentuated in an environment of less industrious behavior (compared to parts of Northern Europe).  This has been a cultural tendency of peripheral countries for decades (if not longer), while the Northern economies like Germany have been the workhorses of the EU.  Not to simplify things too much in a complicated situation, but the lesser-known story of this that there are segments of these countries (Milan and Turin in Italy, for example) that are extremely productive, manufacturing-oriented and perhaps compare better to Berlin than to Rome.  There are productive urban elements within those periphery states that have been taking up the slack and essentially bailing out the rest of the nation(s) for a very long time.

The frustrating part about this whole mess is the political angle.  Despite their grumblings, Germany has as much to lose as anyone in this process.  Since, unlike corporations, sovereign states can’t drop off the face of the earth, they have to be handled somehow—either bailed out or restructured on some other way.  If the Euro breaks apart, or even breaks into two currencies (say, North and South, example), Germany could be hurt due to the likely immediate and dramatic appreciation of that Northern currency—which makes their important export sector less competitive.

At the same time, many politicians don’t have the incentive to ramp up action until the 11th hour (we’ve obviously seen that tendency in the U.S. as well).  Citizens of nations like Germany don’t want to give out any freebies to their seemingly ‘work-challenged’ Southern neighbors, and want assurances of deficit and debt reduction as a condition of any bailout.  Of course, debt reduction can only meaningfully occur if there’s growth, so it’s a catch-22.  Germany would rather act on even greater strength (and deeper peripheral economy desperation), than the other way around.  So, that’s why we seem to be left waiting.

On a more general level, though, banking and fiscal crises are only solved through (1) default or (2) deeper consolidation, time and/or more money.  Default remains an ever-present option and bargaining chip, but no one at the table would prefer this, so they seem willing (although not to the level markets would like to see) to do what it takes to avoid it.  Debt problems can also be solved with time and/or additional cash.  What might also be critical is the creation of a deeper union between countries on a fiscal level, rather than just monetary.  The average post-major financial crisis period of deleveraging takes 5-10 years (although it can take a generation, in more extreme cases), according to economists that have delved into researching these episodes over the last several centuries, and we’re still well within that timeframe.  The risk, of course, is a lack of patience and, if money is printed to help cover the gap, we might have excessive monetary stimulus in the system, which might have some inflationary side effects down the road.  We could face that in the U.S., too.

Conclusion:  despite news changing by the week, nothing has changed from the ongoing story.  This is a multi-year ‘condition’ more than it is a month-to-month ‘crisis.’  The one positive is that the current probabilities of the outcomes at hand may be currently priced in.  Valuations have cheapened a great deal and this means that opportunities might surface selectively.  We shouldn’t write off the continent just yet.

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Markets this week were largely higher—for the fifth straight week—in an environment of summertime light volume and limited positive or negative news headlines.  Energy and technology led from a sector perspective, while utilities and consumer staples on the defensive side lagged.

U.S. treasuries were down a bit on the week as risk-taking was the trend, but credit, floating rate and foreign issues earned positive returns.

Commodity markets were led by energy last week, while agricultural contracts pared back a bit.  In recent weeks, there’s no surprise that grains have been strongly affected by the severe drought conditions in the central U.S.  In fact, one report mentioned that half of all U.S. counties have now been declared a ‘disaster’ areas (although this is not always as severe a status as one might assume; this merely allows those counties to apply for U.S. government financial aid).

Several grains, such as corn, play a critical role in the economy.  Other than the more obvious summer corn-on-the-cob, it affects cereal prices, but even more relevant is the input cost to animal feed (corn is 90% of this), sugar derivatives like high fructose corn syrup (which everything seems to contain) and ethanol as a gasoline additive/filler.  All of this takes corn, and, although we produce a huge amount of it, natural disaster and weather can affect commodity prices dramatically.  This affects the prices of many products, including indirectly to poultry and meat producers.

At the same time, while this is terrible news this summer, commodities have the tendency to eventually self-correct.  A shortage (and high prices) one year usually results in a higher planting percentage the next year.  Then, as weather conditions are often less extreme, we produce too much, bringing prices back into line again.  This may take some time, but is a common pattern for agricultural commodities.

Have a good week.

Karl Schroeder, RFC, CSA, AACEP

Investment Advisor Representative

Schroeder Financial Services, Inc.


Sources:  FocusPoint Solutions, Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, Goldman Sachs, JPMorgan Asset Management, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Thomson Reuters, Schroder’s, Standard & Poor’s, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research.  Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends.  Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness.  All information and opinions expressed are subject to change without notice.  Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.  Schroeder Financial Services, Inc. is a registered investment advisor.