Heads or Tails: Understand the Economic Winds

March 10, 2014
Ending 2013 with a tailwind, the economy’s winds turned in the beginning of this year. The leading indicators do not signal a recession, however; just a slower pace of growth.

On a flight from Oakland to Boston, tailwinds pushed our speed to 700 mph, and we arrived in Boston almost an hour early. Nice when that happens, but rare. 2013 ended with a tailwind, with annual retail sales, non-defense capital goods new orders (excluding aircraft), industrial machinery new orders, and the stock markets all reaching new highs. Annual automobile production saw its highest levels since 2003. Manufacturing, as reflected in ISM’s Purchasing Managers Index (PMI), posted its best results for 2013 the last two months of the year.

Then we turned the page on 2014 and were reminded that the economy is cyclical, not linear. Strong gusts hit the stock market. Other sectors took a hit as well.

The Dow and S&P 500 in January 2014 were the worst they’ve been since the mid-1990s. Conventional wisdom suggests that a bad January portends a bad year for the markets. Perhaps. On 22 occasions since 1950, a poor showing in January resulted in an off year for the markets, so 68 percent of the time. However, the last four times January was down, the year ended up 16.4 percent. February started shaky, but then both the Dow and S&P rallied to new highs. Then the Crimea/Ukraine invasion occurred and rattled the markets.

The markets, however, are not our strongest indicator of future economic growth. We are more focused on the recent drop in the PMI, which fell from 56.5 in December to 51.3 in January. Granted, there was a buildup in inventories in late 2013, a slight data revision, and brutal arctic weather conditions across the U.S. But this key indicator is worthy of attention. The February PMI inched higher, but the internal signals still reflect weakness, which is expected to get more pronounced later this year.

In addition to the PMI decline, our ITR Leading Indicator in January hit a 25-month low (raw data). Once again, February improved slightly, but together with the PMI, we are presented with two leading indicators giving a tentative early signal of softening (deceleration) in the economy as we progress toward the end of this year and into 2015. Add the recent drop in disposable personal income and the 30-year low in the labor participation rate, and what has been healthy consumer spending could soon be slowing.

There is also anxiety over uncertainty in global economies. The Ukraine, Russia and Crimea headlines are proving worrisome for the markets. Although the U.S., European Union and United Nations expressed displeasure over Russia’s actions, it is unlikely that events in this region will spread or impact the world economy in the long haul. Short-term movements in energy prices, grain prices and stock markets are to be expected.

U.S. debt remains in high demand as national governments, pension funds and Baby Boomers look for safe investment options. In a world of uncertainty, investors want the most trusted (or the least risky) choice, which is the U.S. dollar. This is a sweet deal for the U.S., but has created some instability on foreign currencies and economies. Countries that cut interest rates in 2013 to boost economic performance are finding themselves with depreciating currency values and foreign reserves. Among those feeling the pinch are Argentina, Turkey, Peru, Chile, Colombia and Mexico. Foreign trade accounts for about 31 percent of the U.S. GDP. There are more than 140 countries in which foreign trade accounts for greater than 31 percent, with the majority of those trades in U.S. dollars. A stronger U.S. dollar can lead to higher inflation at home, which constricts consumer and business growth.

However, the U.S. benefits from a stronger dollar. Interest rates are slower to rise than if the dollar were at risk. Lower borrowing costs spur business investment, and consumers can fill the gas tank, pay the rent and spend more at the mall, despite a soft job market. A strong U.S. dollar also means the U.S. is importing less inflation. In 2014, we expect U.S. interest rates to be largely flat and inflation relatively mild.

But there are downsides to the strong dollar. Because money is cheap here at home, there is less incentive for Congress to take seriously our mounting deficits and debt. For the global economy, the U.S. dollar’s strength (and their currency weakness), makes U.S.-made goods more expensive in foreign markets where there are national competitors. This can hurt Automation World readers who depend on exports. U.S. exporters are already feeling margins squeezed by currency fluctuations.

This is not meant to sound ominous, just cautionary. The U.S. economy remains one of the better performing economies in the world. The leading indicators we watch are not signaling a recession in 2014 or 2015, just a slower pace of growth. The U.S. dollar alone will not unravel the entire global economy, but it will continue to present a challenging socio-economic environment in 2014 for leaders and central banks. Our advice is to beware of linear projections and be aware of the impact on demand for your goods overseas, potentially less-expensive imports, and margin-squeeze caused by currency fluctuation.

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