Shapiro Metals- May Market Insights
May 13, 2022
As Bob Dylan would say, it doesn’t take a weatherman to know which way the wind is blowin’.
The effects of the Putin war in Ukraine, pandemic-prompted lockdowns in China, and high inflation are wreaking havoc throughout the world on a humanitarian and economic basis. In an opinion piece in The Wall Street Journal, Shirley Yu, senior fellow at Harvard’s Kennedy School, states that none of the current factors will stagnate long-term global growth. Rather, they will accelerate growth, driven by the escalating global commitment to invest in technology and innovation as we deglobalize. I sure hope so. This is a fascinating article if you get the chance to read it.
Inflation
The Consumer Price Index (CPI) for April was just released and the headline is that the rate dropped .2% to 8.3% from March last year. It is just under 8% on an annual rate, but core prices for CPI – which exclude the typically volatile food and energy sectors – rose .6% from March’s .3%. That is not a good sign for inflation.
Core PCE, Personal Consumption Expenditures, is what the Fed uses to measure inflation. It rose 5.2% in March on a 12-month basis, which is a small drop from February; including food and energy, it rose 6,6%. April numbers will be released this week.
The Producer Price Index for March was up 11.2% on a 12-month basis and 14% month-over-month – the highest in 47 years. One of the biggest culprits is long-term freight rates, which are up more than 36% year-over-year; that’s the highest on record. Transportation capacity was higher in April, but diesel fuel costs are considerably higher. The rest of the April PPI will be out this week.
Manufacturing
In US macro news, total durable goods orders increased 0.8% month-over-month in March (consensus +1.1). Excluding transportation, orders were up 1.1% (consensus +0.5%). New orders for nondefense capital goods — a good proxy for business spending — jumped 1% following a 0.3% decline in February. The shipments for the “core” components rose at a 15.8% annualized pace in Q1 versus the Q4 average and provide a healthy tailwind to first quarter GDP growth.
The ISM manufacturing index was down again in April to 54.4, falling from 57.1 in March. The main causes are uncertainty over the Putin war and supply chain issues. Supply chains are also being hurt by the Chinese Covid lockdowns, which are draconian in nature. The US is so fortunate to have safe and effective vaccines that work.
The two most forward-looking indices, new orders and production, both posted declines in April but are still over 50, which puts them in the growth area. Demand continues to be strong while inventories are still slowly recovering. Prices are still very high, but a temporary light at the end of the tunnel for metals might be emerging, which I will cover later.
Orders for new cars were up 5% in March, but production is slow. The volatile orders for commercial and defense aircraft fell in March. New home sales fell in March for the third month in a row, but housing starts are at the highest level since 2006. The main problems are a shortage of finished housing and rising interest rates. And as commodity prices rise, the Case-Shiller Home Price Index is up 19.8% versus a year ago.
The Shapiro Nonferrous Scrap Activity Index for April fell back to January-February levels and was down 10% from the March highs. Most sectors were down — except for aero, which was up slightly – and auto was down more than most sectors.
The Economy
Many people reading about the 1.4% GDP drop in Q1 wondered if the number was a typo. Real GDP did decline at a 1.4% annual rate in the first quarter, which looks like it could be the start of a recession.
GDP = private consumption + gross private investment + government investment + government spending + (exports – imports)
These three core components that make up part of the GDP were up 3.7% on a weighted average annual basis:
- Consumer spending: up 2.7%
- Business fixed investment: up 9.2%
- Home building: up 2.1%
That certainly does not look like a recession. The huge increase in imports dragged down GDP. Also, inventories rose at a slower rate, and government purchases were down. The net effect was a 1.4% decline. However, nominal GDP (real GDP growth plus inflation) rose at a 6.5% annual rate in Q1 and is up 10.6% from a year ago. It is very complex. Expectations are that GDP will be up in Q2 once the negative drags end.
We basically have a healthy economy. Household spending and business investments are strong. Matt Klein reports: “Domestic production has dropped during periods of rising consumer spending and business investment only once before: 1982 Q3.”
Employment is good. The number of people working is only 1.2 million fewer than pre-pandemic. Employers have added an average of 552,000 jobs a month for the past six months.
Job openings are a whopping 11.5 million. One reason for fewer people working is that many have taken early retirement. They have seen their home values rise and their stock values from 401K and savings grow substantially. Even with the markets’ recent declines, the retirees are far better off. And some of them may decide to get back in the job market again with inflation and lower stock values.
Pent up demand continues for goods and services. With $2.5 trillion in excess savings accumulated from pandemic distributions and two years of Covid, people want to get back to enjoying themselves.
The Recession
So where will the recession come from? It is due to taming high inflation. Inflation needs to be managed, and the Fed has finally seen the light. It started raising the interest rate this month by a half-percentage point and is considering more rate hikes until they get to 3% or 3.5%. The Fed also has turned from quantitative easing to quantitative tightening to lower the money supply, called M2.
Fed Chairman Jerome Powell believes the interest rate increases and reducing the money supply will slow the economy enough to take pressure off the labor market, which he describes as a “tight to unhealthy level.” The Fed policy is committed to a soft landing.
As I discussed last month, a growth rate of 6% in the money supply is necessary for a soft economic landing. That 6% M2 growth rate is what we largely have experienced with the Fed generally keeping the interest rate at zero since the 2008 Great Recession. During that time, inflation was under 2%. Now, the M2 growth rate is 11% and has been elevated for over a year. Inflation is over 6%, and many blame the government stimulus payments. You can blame part of inflation on that, but the rest of the world is also experiencing nearly the same inflation and didn’t have that much government spending.
In the past 80 years, the Fed has not been able to reduce inflation by 4% without causing a recession. It is like trying to navigate an obstacle course where new obstacles are popping up all over and bullets are flying. Bringing inflation down will require improvements with supply chains and logistics in addition to more people entering the labor market to take the edge off of wage price gains. If that happens, we could have a chance for a soft landing. I am happy that fixing this is not my job.
China
China was the first country to go into Covid lockdown in 2020 and the first to come out and do well. Their Covid zero-tolerance policy has more than 180 million people on lockdown and afraid to even go out of their compounds. Many have trouble getting food and medicines. Some manufacturers are operating only because their workers are living on-site. Shanghai, with a population over 25 million, and other major cities are on total lockdown. Can you imagine if Texas, with a 30 million population, was on total lockdown because of a few hundred cases of Covid a day?
China doesn’t measure consumer confidence, but it can’t be good and will hurt consumer spending. The housing sector, a major consumer of metals, is still having severe problems. Both the official PMI [47.1] and the Caixin [46.0] have fallen into contraction and are down over two points from March. The International Monetary Fund continues to drop GDP forecasts in China, now predicting 4.4% growth, the lowest since 1990.
The lockdown policy is detrimental to growing the economy, logistics, and supply chain. However, President Xi Jinping has doubled down on his zero-tolerance policy. China has had over 5,000 Covid deaths and over 1 million cases, whereas the US has had over 1 million deaths.
The Putin War
Putin’s war poisoned the well. Thousands of people are needlessly dying and Ukraine is being systematically destroyed. People are suffering and are not able to get humanitarian aid. While the human side is a horrific tragedy, the rest of the world is, and will continue to, suffer greatly economically. Twenty-five percent of the world’s grain comes from Ukraine and Russia, and a significant percentage of fertilizers were also produced there. These products will be in short supply this year and for a long time to come. People will needlessly suffer worldwide hunger and a surge in inflation because of one semi-human being.
After 10 weeks of fighting, the Russian army looks unmotivated and incompetent. The US is giving massive intelligence and military aid to Ukraine. For example, Russia’s “world class” ship, Moscova, was destroyed with US military assistance, and 12 Russian generals lost their lives with our intelligence help. The US and NATO are learning that Russia is weak and incompetent.
Putin continues to show disregard for Ukraine and his own people. The US and NATO have sent clear messages that Putin can’t, and won’t, win. As the Russian people suffer economically, they will grow tired of the war. But not much will happen until Putin realizes he is unable to win. His nuclear option is still a threat, and I am sure [hopeful] Putin understands the consequences of mutually assured destruction.
Metal Prices
Greed and fear always play a large part in metal pricing. Fears of tight metal supplies and shortages have been replaced by the fear of recession and lower demand. China’s slowdown is hampering production, supply chains, and logistics. Consequently, all May prices have dropped and are weak.
I am not sure where the bottom is. I do know that our economy is growing and should continue to grow. Most manufacturers we service have good orders and strong demand. However, they are still faced with labor and supply chain issues. Since China is slowing and is one of the largest consumers and producers of aluminum, steel, and copper, metal prices will remain soft.
- Spot prime aluminum dropped 18 cents per pound from April due to the LME drop.
- The Midwest premium remained flat at 40 cents per pound, reflecting tight inventory levels and high freight costs.
- The AMM segregated average scrap price dropped 16 cents per pound.
- Secondary smelters’ aero turnings prices held steady.
- Copper and stainless steel prices were down 10% from last month.
- Nickel was down 3%.
- Steel prices will be down about 10%.
Despite these drops, most prices are still substantially above last year’s.
“People don’t realize that we cannot forecast the future. What we can do is have probabilities of what causes what, but that’s as far as we go. And I’ve had a very successful career as a forecaster, starting in 1948 forward. The number of mistakes I have made are just awesome. There is no number large enough to account for that.” –Alan Greenspan, former Fed Chairman
Life is good. Family and health are precious.
Bruce Shapiro
Comments are appreciated. This report was prepared by Bruce Shapiro and reflects my current opinion of the economy. It is based on sources and data I believe to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice.