Looking forward to 2016, there are a number of reasons to be concerned. There are also some reasons not to be concerned,” said economist Chris Kuehl of Armada Corporate Intelligence, speaking at the Fabricators & Manufacturers Association annual meeting Feb. 25 in San Diego, Calif.
Most economic forecasts for 2015 missed the mark, Kuehl said. Experts predicted the Fed would raise interest rates in June, or at the latest September, when in fact it did not happen until December. The price of oil had bottomed at $60 a barrel and an upturn was imminent, many said. Then it plunged to $30. But China’s state-run economy would surely rebound, they agreed. Hasn’t happened yet. “Half the economists thought we were in the middle of a recession already. The other half said we would probably grow by 3 percent. At the end of the day, we were both wrong,” Kuehl said.
Much of the current downturn in the U.S. can be traced back to China, though indirectly, he explained. “China is the second-largest economy, yet we do not do a whole lot of business with them. We sell to the countries that sell to China. So if China is not buying, they are not buying, and that becomes an issue for us.”
China’s growth has slowed dramatically as the country tries to transition to a more consumer-centric economy. The country’s goal is to be a low-cost producer that is less dependent on exports. “But any low-cost producer is vulnerable to the next-lowest-cost producer,” he notes. Competition from manufacturers in Vietnam and South Korea, for example, are challenging China’s position.
Developing a more skilled workforce, and a consumer class that can afford to buy the goods the country produces, is raising wages in China above those paid by competitors in other parts of the world. “It is now cheaper to hire someone by the hour in Mexico than it is in much of China,” Kuehl noted. Like in Japan, consumers in China tend to save rather than spend, which does not help fuel the economy. Creating a consumer culture will take time.
Nevertheless, China is still growing at a faster rate than any other country. And it has to. To keep pace with the needs of its labor market, China has to create 1.4 million new jobs per month, compared to about 300,000 in the U.S. “They cannot do that at less than 6 percent growth. They are really near recession,” Kuehl said.
Weak energy prices are having a huge effect on the U.S. economy. In the past, the OPEC nations could stabilize the oil price by controlling the supply. Today, with new production techniques like fracking, North America has become a major oil and gas supplier. Saudi Arabia can no longer control the market on its own. Yet it continues to try by overproducing in the hope the oversupply will drive the price down to a level that will force competitors out of business. “American producers have invested billions and they are not going to walk away. They will suck it up and compete as long as they have to. They are not intimidated by the Saudis,” Kuehl said.
That power struggle will likely keep energy prices low for some time. During the 2008-09 recession, American oil consumption dropped to about 10 million barrels a day. Today, thanks to the low prices at the pump, it has rebounded to about 20 million barrels, nearing pre-recession levels. But Europe is still consuming about half as much oil and Asia about two-thirds. “Demand will have to recover in those parts of the world before the price of oil goes back up,” Kuehl said.
Although difficult to predict, the price of oil is expected to range around $50-60 per barrel for the next two years, depending on consumer demand for gasoline and changes in refinery capacity. AAA expects the busiest driving season in 20 years as people opt to take the family car, rather than an airplane, to their vacation destination. Despite their lower fuel costs, airlines have not reduced fares much, but instead are spending the windfall on new aircraft.
Uncertainty caused by fluctuations in the labor market and the stock market are major sources of anxiety for most Americans. While the official unemployment level is good at under 5 percent, the actual rate is more than double that when considering involuntary part-time and discouraged workers, Kuehl said. Adding to the public’s concern is the volatility in the stock market, which has experienced huge price swings. Don’t panic, said Kuehl. The U.S. economy is still the strongest in the world. Investors in Europe and Asia have nowhere else to place their money. “They rush in an out of the market causing wild gyrations that are unrelated to the underlying economic conditions.”
The strong dollar continues to be an issue because it makes U.S. exports less competitive, “but then who would we be selling to? The folks in Europe, Asia and Latin America are all broke. Brazil is in a depression,” Kuehl said.
Looking past the gloomy headlines, economic data suggests the U.S. economy is fine, he continued. Key indicators are trending up including jobs, housing, manufacturing, industrial production and capacity utilization. Consumers have money to spend, partly thanks to cheap gasoline. Housing prices are going up, but not so fast they are crowding buyers out of the market. New-home construction has boosted appliance sales. The auto industry sold 17.5 million vehicles last year and is on track to do it again. Aerospace orders are backlogged. Durable goods orders recorded an unexpected bump of 4.9 percent in January. The agriculture market is even showing signs of new activity. “Ag equipment eventually wears out and has to be replaced whether the harvest is good or bad and commodity prices are high or low,” he noted.
The Institute for Supply Management’s Purchasing Managers Index has been below 50 for the past few months, which means U.S. manufacturing has contracted. But ISM’s New Orders Index, which is a predictor of future business, is well above 50. The Credit Managers Index, which tends to predict the PMI, has shown a three-month increase in applications for credit, which bodes well for future purchasing. “If it keeps going in that direction, that’s a good sign,” Kuehl said.
While it is true the metals market has suffered through “a prolonged period of mediocrity that has not been a whole lot of fun,” the commodity markets experienced a major boom prior to the recession that makes the current correction seem worse than it really is, he said. “Even with the downturn in oil, if you look at where we are now compared to where we were prior to the recession, we are better off.”