Shapiro Metals – November Market Insights
November 11, 2022
THE LONG AND WINDING ROAD
When we headed out on vacation as kids and our parents were driving, we knew where we were going. We just didn’t know how far away the destination was and how much time it would take to get there, so we kept asking, “are we there yet?” The Fed is driving this economy and knows we want to get back to growth with low inflation and full employment. Unfortunately, the road to get there isn’t clear. The speed limits keep changing, there are many detours, weather changes from rain to snow — and watch out for that black ice – and unexpected accidents keep happening. Looking ahead is never clear, and it is the same with the economy.
The Consumer Price Index (CPI) for October fell 0.5% to 7.7% year-over-year and fell 0.4% on a monthly basis. The core price index, excluding food and energy, fell to 6.3% from last year and was down 0.3% from last month. Medical costs and used cars fell while shelter was still strong. CPI was lower than the economists estimated, although it is moving in the right direction and may slow the Fed’s need to raise interest rates at a faster pace.
The Producer Price Index for October will not be released until Tuesday.
PCE (personal consumption expenditures), which is the Fed’s preferred measure of inflation, rose 0.3% in September and 6.2% from the previous year. These increases are similar to last month.
The Fed’s latest 75-point interest rate hike and the expectation of another 50-point increase in December were both unsurprising. First, the Fed noted it anticipates ongoing hikes will be appropriate until it reaches “a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.” No one knows what “sufficiently restrictive” means in terms of future rate changes, except that it will depend on the data. The Fed also set expectations that it will consider the “lags with which monetary policy affects economic activity and inflation.” So, we know the destination but not how long it will take to get there.
Inflation forecasts for next year are lower. JP Morgan believes that headline CPI will be 3.2% next September, while UBS thinks it will be 2% next December. Inflation-linked bonds and derivatives project that headline inflation will be 2.9% a year from now, according to Intercontinental Exchange.
Many economists believe there will be a recession in mid-2023. Higher interest rates will eventually slow the economy and decrease the labor demand so the wage price spiral will reduce. However, there is a lag in rising unemployment. As the economy slows, employers are fearful of layoffs because of the current labor shortage. These delayed layoffs, or reduced layoffs, are just one more complexity in the Fed’s calculus for bringing inflation under control.
There is a case for a soft landing if inflation reduces while the labor market cools down a little, but not a lot. The key is managing inflation expectations. Consumers don’t anticipate that inflation will be as high in the future as it is now. The five-year long-term bond market also sees inflation at 2.3%. Bringing inflation down will take at least a few years.
Home sales are the one sector where interest rates are having a direct, immediate impact on slowing the economy. Home prices have dropped slightly the last few months, but sales are coming down faster as the 7% mortgage rate significantly raises the cost of owning a home.
The labor shortage continues as the jobs created in October rose by 261,000 and the unemployment rate stayed at 3.7%. Job openings also increased in September, by 437,000, to a total of 10.7 million openings. Many believe that there will be a permanent labor shortage due to retirement during the pandemic and the boomers aging out of the workforce.
There is also good news for wage increases. The employment cost index, a broad gauge of wages and benefits, increased 1.2% in the July-September period after being at 1.4% in Q1 and 1.3% in Q2. The overall trajectory when using a three-month annualized metric to smooth out month-to-month volatility shows that earnings inflation continues to cool, even without a significant increase in unemployment.
GDP was up 2.6% on an inflation-adjusted basis in Q3 after two negative quarters earlier this year. Consumer spending is lower than during the first half of the year, but it is still strong. Consumers still saved $1.5 trillion from the PPP stimulus in 2020 and 2021 and are in good shape. This will ease the effects of the recession.
According to Timothy R. Fiore, chair of the ISM Manufacturing Business Survey Committee, “The U.S. manufacturing sector continues to expand, but at the lowest rate since the coronavirus pandemic recovery began. With panelists reporting softening new order rates over the previous five months, the October index reading reflects companies’ preparing for potential future lower demand.”
On the negative side, the supply chain index fell for the fifth straight month, employment fell into contraction, and the price index fell. All of these are now the lowest they have been since the pandemic started, reflecting a slowing economy and slowing inflation.
- Shipments of “core” non-defense capital goods ex-aircraft (a key input for business investment in calculating GDP) are a leading indicator for manufacturers. They were down 0.5% in September but still up 6.3% in Q3 on an annualized rate, compared to Q2.
- Orders for core capital goods, which will lead to shipments in the future, were down 0.7% in September. These orders have recovered sharply since the pandemic, up 72.6% from the April 2020 bottom, and now sit 18.7% above pre-pandemic levels.
- The ISM Manufacturing Index for October fell to 50.2 from 50.9 in September. The new orders index rose in October but is still in contraction.
- Manufacturing job openings decreased by 40,000 in September, to 806,000, which is seasonally adjusted. Openings in September 2021 were 941,000. This is still very strong especially when compared to the pre-pandemic high of 520,000 in November 2018.
- The industrial production index rose 0.4% in September, reaching a new record high. ITR believes the high was an anomaly considering leading indicators have been dropping for a year. It forecasts a potential bottom and soft landing for industrial production in the middle of next year followed by continued growth through 2024.
- Capacity utilization in the manufacturing sector hit 80.0% in September, the highest level since 2000!
- The Shapiro Nonferrous Scrap Activity Index for October rebounded from September’s 6% drop. It was up 7% from our yearly average.
As the pandemic has become “normal,” consumer spending has shifted from goods to services. Despite the talk of a recession, manufacturing still looks very good. The early October report shows that after adjusting for inflation, “real” retail sales are up around 13.5% over the same period, so consumer spending is still strong.
However, chip shortages still plague the auto industry two years after they began. Toyota has cut back worldwide production 10% this year; even so, producing 9.2 million cars will be a record for them. With each car using hundreds of chips, even the lack of one or two can reduce the number of cars produced. Other chips used in electronics industries are now being overproduced, but the chips needed to make cars are still in short supply. This is part of VUCA (volatility, uncertainty, complexity, and ambiguity).
CHINA AND THE WORLD
China’s GDP for the first nine months this year is 3%, which is far below its forecasted 5.5%. Both the official PMI and Caixin are in contraction. PMI was down to 49.2 from 50.1, and Caixin was down to 48.4 from 49.3 last month. They will continue to remain there with a Covid Zero policy that has much of China still in lockdown and taking daily Covid tests, which scares consumers. It will also take years for China’s housing oversupply to get back in balance. On the plus side, the reduced demand for oil in China will help keep oil prices down.
At the recent Chinese Communist Party congress, President Xi took a position to focus inward and become less reliant on the world. Many countries are moving politically to the right. As we saw with Russia and Europe, mutual economic reliance does not make you freer and safer. The pendulum swings, and the times they are a-changing. Eventually, all the 70-plus-year-old world leaders will be replaced with a younger generation that is hopefully wiser.
Europe also continues to struggle with its PMI, which is in contraction, and inflation at over 10%.
For those of you working on your 2023 budgets, Edward Meir from ED&F Man was recently at the annual London Metal Exchange dinner. He stated: “HARBOR continues to see LME prices targeting $2,000 per metric ton before year’s end, and potentially as low as $1,700–$1,450 per metric ton in 2023. For 2023, we expect LME Cash aluminum prices to average around $2,100 per metric ton in our base forecast scenario (50% odds). HARBOR’s base forecast remains the most bearish among the universe of analysts we track every month, where the consensus forecast for 2023 has been downgraded to $2,535 per metric ton (from $2,948 per metric ton three months ago).”
He also said the Reuters consensus poll that was released last week “has aluminum cash prices averaging $2,413 in 2023, down from the predicted $2,688 for 2022. The poll has the deficit coming in at 200,000 for this year before tipping into a 300,000-ton surplus in 2023.”
Summing up the meeting, Meir said that Andy Home of Reuters recapped the LME in one succinct paragraph: “The world is going to need a lot more metal if it is to meet its carbon reduction targets. Unfortunately, current prices are too low to incentivize the necessary investment in new mine and smelter capacity. It’s a major conundrum which can be added to the puzzling mix of bearish outright pricing, existing supply disruption, potential Russian supply disruption and, in several cases, critically low exchange inventory. Confused? Don’t worry. So was just about everyone else in London this week.”
The seven-month downtrend in metals prices nearly flattened out this month. Consumption for all metals slowed as most of the supply chain has almost caught up. We still see manufacturing busy in many sectors we cover as plants still face labor shortages.
Prime aluminum fell 3 cents per pound from October, with almost the entire drop coming from the Midwest Premium, which hovers near 20 cents. Prime scrap was also down a little on the segregated average and up a little on a few of the others. Aerospace turnings also fell for the sixth straight month. Copper was up slightly, while stainless was down 16%. Steel prices were also flat, to down a little. Steel capacity utilization was 74.5%, down 9.4% from last year. HRC and iron ore prices are at two-year lows and down about 70% from their recent peaks.
In election years, we are bombarded with negative, ugly ads. It is depressing and disheartening. It is important for me to remember and be thankful for the many things we have. We live in a country that is a democracy and where we have many freedoms that are denied in other countries. While crime is certainly a problem, most of us live in safe areas. We have religious freedom and voting rights. Education is readily available. We have access to health care, and jobs are plentiful. While we fight inflation, everyone who wants to work can work! I recognize it certainly is not a perfect system, and for all the freedoms and benefits I mentioned there are lots of “yeah, but” arguments.
I am grateful to have the opportunity to live here. I am grateful to all of you who entrust us with your business and read my monthly comments. It means a lot to me. May you have a joy-filled holiday and count your blessings!
“We succeed by helping others.” -Simon Sinek
Life is good. Family and health are precious.
Comments are appreciated. If there are other people you know that would like to read this, let me know and I will add them to our distribution list. 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