The headlines in October were dominated by five continually revolving, news-grabbing topics: Ebola, the stock market, Europe heading toward a possible third recession in six years, ISIS, and oil prices. Ebola is not an epidemic; end of story for the U.S. Europe, specifically Germany’s manufacturing sector, slowed significantly (-5.3 percent in August), creating fears that the European Union is heading for its third recession in six years. However, one month does not make a trend. We are monitoring the situation in Europe, but we expect very slow growth for the entire EU (0.9 percent in 2015) over the next year and a half.
The stock market trend through October hasn’t changed our thinking about the general economy going forward. We saw a similar event in January of this year. It would have to go a lot deeper and last a lot longer than three weeks to make us rethink our growth outlook for the U.S. Certainly the case can be made for a better S&P 500 trend in the future given the probability of an accelerating economic environment for 2016 and global liquidity. A healthy adjustment (correction) in stock prices only helps clear out some of the excesses from the system before they reach dangerous levels. The Federal Reserve Board revised its forecast upward for output and employment next year at its September meeting. Recent volatility in the stock markets seems likely to help hold off any rush to raising rates.
The drop in oil prices to the low $80s a barrel is unusual, but not a crisis. If the price stays this low, the September-to-October price trend will be larger than normal for this time of year, and large enough to usually go hand-in-hand with a cyclical downturn in the U.S. economy. We think there is a good that chance oil prices will be flat to mildly rising in the near term. Crude oil futures prices are essentially coincident with U.S. industrial production through business cycle highs and lows. Note that the U.S. is not in a downturn and the leading indicators are saying that one isn’t probable. U.S. macroeconomic conditions are the driving force behind these lower prices.
The decline in prices basically reflects economic fundamentals—the decline in demand abroad and the expansion of supply domestically. General economic weakness occurring in Europe, Asia and South America is sapping oil demand globally, but not in the U.S. Activity in Japan and China is slowing, and we are projecting recession in several Western European economies into next year. The U.S. has become mostly self-sufficient due to the domestic oil and gas boom. U.S. oil and gas extraction is accelerating, with the annual trend registering a 10.0 percent increase over the year-earlier level. We expect the trend to accelerate through year-end. At the same time, despite the drop in price, world production is up as top OPEC producers refuse to consider cuts to production ceilings, preferring instead to try to maintain market share as prices tumble.
In short, the recent movement in oil prices is not something to cause any major concern for U.S. companies that don’t have direct, unhedged exposure to short-term price spikes; nor does the price trend signal any serious danger to the broader U.S. economy.
The macroeconomic data about the U.S. economy provides an altogether different story. The U.S. economy is in good shape, and North America in general is expected to outperform other global economies over the next few years. U.S. industrial production (manufacturing, mining, electric generation) remained strong through September, with annual growth accelerating to 3.8 percent. Expect the rate of growth to pick up further through year-end, supported by favorable business conditions, positive leading indicator trends, employment gains, consumer spending, and lower-cost energy. It is worth noting that the U.S. economy has been expanding for the past two years, despite Europe’s troubles, China’s slowdown, South America in recession, and sanctions on Russia.
General business-to-business activity, as reflected in the Purchasing Managers Index (Institute for Supply Management), is well above the benchmark number of 50 (56.6). There are signals of some mild cooling off after the first quarter of next year, but no cause for alarm. Annual nondefense capital goods new orders rose 5.0 percent above the same 12-month period last year. Annual new orders will generally expand through 2016, although the pace of rise will moderate in 2015. Annual industrial machinery new orders stand 31.3 percent above last year, reaching record-high levels. Annual material handling equipment new orders jumped in August, up 9.8 percent above the year-ago level with quarterly orders spiking to 18.1 percent above last year. Annual construction machinery new orders continue to post double-digit growth rates, though the pace of rise is easing. Most sectors of wholesale trade, while showing signs of slower growth, are rising at a healthy pace.
Employment rose and the unemployment rate eased to 5.9 percent in September. This time last year, the unemployment rate was 7.2 percent. The fact that more people are getting paid for doing work is a sign that businesses see a need for labor in response to growing demand. Job openings for the last quarter are 20.4 percent ahead of this time last year, an 11.5 percent increase in the past 12 months.
The real news from retail sales is, not so shockingly, nowhere near as dismal as some headlines imply. Retail sales for September made headlines for coming in below August and disappointing some economists, down from August by 6.9 percent. This month-to-month decline is milder than each of the last two years and milder than the average decline posted over the past 10 years. The overall seasonal rise in retail sales since the first quarter is the strongest since 2005. A 50-cent drop in the price of gasoline since May should mean better margins for businesses and a merrier Christmas for retailers. Retail sales will move generally higher through 2015 before more robust growth takes hold in 2016.
The leading indicators that we track are giving no indication that the U.S. economy is in trouble. There are early signs in some of these indicators pointing toward a very mild slowdown in the macroeconomy next year. A strong dollar will be troublesome for U.S. exports through the near term. Instead of listening to the headlines, prepare for increasing activity. Increase your line of credit to your best customers. Use the breathing room in 2015 to identify bottlenecks and improve processes. Shorten response and delivery times where possible to beat competitors and to gain market share. Be sure you have sufficient financing, raw materials, labor and capital set to go for a more robust economy in 2016 and beyond. This is not the time to be looking over your shoulder at what was, but the economy is providing more opportunities and pushing businesses that want to succeed to take more risks.