Shapiro Metals – December Market Insights

December 14,2022 

A FUNNY THING HAPPENED ON THE WAY TO THE RECESSION 

During periods of inflation, interest rates typically go up and the economy slows down. People lose their jobs and GDP drops. Everyone calls for tax cuts and stimulus programs. But the government’s reaction to the pandemic was to front-load the stimulus programs. For over two years, we have had a good economy with a hot job market and growing inflation. 

Former Treasury Secretary Lawrence Summers, now an economics professor at Harvard, warned about inflation long before it recently became a problem. He currently believes it will take a lot longer to bring inflation down to the Fed’s 2% target and that interest rates will climb to 6% next year. “For my money, the best single measure of core underlying inflation is to look at wages,” he said. With wages up over 5% annually and the job market strong, bringing inflation down is a challenge. Meanwhile, prices have been dropping sharply for oil, shipping, trucking, lumber, metals, and market-based measures of rents, used cars, and more. 

We are in a new cycle that is not like other cycles we have seen before. There is still over $1.3 trillion in savings to help us weather the storm. I am counting on the economy slowing down as interest rates rise. We can never know how long inflation will last or how severe it will be, but most of us who have been through these downturns before will take appropriate actions. We know that things will change and we will be back in good times again. When? I can’t say. 

INFLATION 

The newly released Consumer Price Index (CPI) numbers rose less than expected in November, indicating inflation eased a bit. The CPI rose in November to 7.1% year-over-year, marking the slowest 12-month increase since December 2021. That’s a 0.6% drop from October’s 7.7% year-over-year stats. CPI rose 0.1% on a monthly basis, compared with October’s 0.4% month-over-month rise. The core price index, excluding food and energy, rose only 6% year-over-year and was down 0.3% from last month. Medical costs and used car prices fell while shelter was still strong. The CPI is moving in the right direction and may tamp down the Fed’s inclination to raise interest rates at a fast pace, but it still has a long way to go. 

The Producer Price Index for November is at 7.4% annually and down from 8.1% in October. It has now risen by 0.3% for each of the last three months, with food and energy prices continuing to experience large swings. Outside these typically volatile food and energy categories, “core” producer prices rose 0.4% in November and rose 4.9% from a year ago, down from 5.4% in October.  

PCE (personal consumption expenditures), the Fed’s preferred measure of inflation, dropped in October to 6% on an annual basis, compared with 6.3% in September. On a monthly basis, it was up 0.3% in October, the same as September. Core inflation in October dropped to 5% from 5.2% in September. This gives the Fed a little more room to reduce the size of the interest rate increases. 

The Fed’s strategy is to raise interest rates gradually and watch what this does to slow the economy. The next Fed meeting is this week and will bring a 0.5% rate increase, bumping rates from 4.25% to 4.5%. Traditionally, many economists believe that the maximum impact of rate increases comes 12 to 24 months after the Fed actually raises them. Using that theory, we will see the slowdown/recession just in time for the next election. Fed Chair Jerome Powell stated, “If you’re waiting for actual evidence that inflation is coming down, it’s very difficult not to over-tighten. We think that slowing down at this point is a good way to balance the risks.” 

The Fed is still a long way from its 2% target. Trying to gauge inflation falls under my favorite acronym: VUCA (volatility, uncertainty, complexity, ambiguity). Inflation has been “volatile” and mainly on the upside. When inflation will come down is “uncertain.” Trying to bring it down and control it is “complex” as hell. How long this will take is “ambiguous” — but it will take more time than any of us want and cause pain to those who lose their jobs. 

MANUFACTURING 

The shift from goods to services continues. This is reflected in November’s ISM manufacturing index falling into contraction at 49.0, down from October’s 50.2. We were last in contraction in May 2020. The November new orders index fell further into contraction. Production is still in expansion. Supply chain issues are improving. 

ITR uses a 12-month moving average to generate its forecasts. When applied to US industrial production in October, the moving average surpassed the previous record high that was set in March 2019. ITR anticipates production will continue to rise into record territory through at least 2024. The rate of change in October did tick down to 4.3%. Using ITR’s analysis, the production rate will continue to generally decline into late next year.  

Capacity utilization in the manufacturing sector dropped in October but is still in positive territory. Capital goods shipments and orders are a very positive sign for manufacturing. Reshoring and capital investments by foreign investors will continue to support industrial production. 

• Shipments of “core” non-defense capital goods ex-aircraft (a key input for business investment in calculating GDP and a leading indicator for manufacturers) were up 1.2% in October after being down 0.5% in September. Shipments are up 6.3% in Q3 on an annualized basis. 
• Orders for core capital goods, which will lead to shipments in the future, were up 2.1% after being down 0.7% in September. These orders have recovered sharply since the pandemic and continue to help the economy.  
• Light vehicle sales rose slightly in November to over 14.4 million units, versus 13.9 in October. 
• US civilian aircraft production continues its long-term uptrend and is up 4% in November over last year. 
• Employment remains strong with a 3.7% unemployment rate. Average hourly wages rose 0.6% in November and are up 5.1% on an annual basis. 

• The Shapiro Nonferrous Scrap Activity Index for November, which tracks our daily purchases for the same accounts across our 10 locations and a diverse industrial base, was down slightly from October and the same as our yearly average.     

CHINA AND THE WORLD 

China’s zero-Covid policy has been a hot mess. The economy sank into a deeper funk last month under the weight of the strict zero-Covid measures, with housing in the toilet and exports plunging 8.7% in November – the most since the start of the pandemic in February 2020. The unemployment rate is near 6% and retail sales fell 0.5%. Both the official PMI and the Caixin are in contraction.    

The government recently relaxed the zero-Covid policy because of the people’s frustration, recent protests, and an economic slowdown in manufacturing and services. China had focused on trying to manage the symptoms and not on the root causes. Their vaccinations are not nearly as effective as the West. Their approach to locking down cities and frequent testing also is having a negative psychological impact, which will take a very long time to change. 

In Europe, business activity contracted at its fastest pace in nearly two years. In November, inflation slowed to 10% from October’s 10.6%. However, wages were up only 3%, compared to over 5% in the US. The world economy will be as weak next year as it was in 2009 after the financial crisis as the conflict in Ukraine risks becoming a “forever war,” according to the Institute of International Finance. The International Monetary Fund expects the global economic growth rate to slow to 2.7% in 2023 – down from 3.2% projected for this year and 6% in 2021 – as inflation cuts into economic activities. 

THE PUTIN WAR 

This attack on Ukraine is now in its ninth month. Russia has inflicted tremendous damage in Ukraine, but it is now losing the war. Ukraine now has the ability to use drones to attack Russia within a 350 radius of its border, and it has used drones within 100 miles of Moscow.  

Ukraine is targeting the Russian oil complex by attacking refineries and pipelines and stifling Russia’s abilities to export oil. This will hurt Russia’s main source of income and could bring about negotiations. Before the drone attacks in Russia, Putin intimated that he would not be using nuclear weapons. Now the saber rattling begins again. If negotiations get started and a settlement occurs, everyone in the world will benefit. This war has been a large factor in worldwide inflation, too.  

METALS 

Metals woke up in November. The dollar has weakened, and there is an inverse correlation between the dollar and metals. Edward Meir of Marex [formerly ED&F] sees the dollar continuing to weaken based on both fundamentals and technicals. Also, he sees inflation slowing in Q1, which will also weaken the dollar. Metal prices will be impacted by the slowing worldwide economies. 

There was hope that China’s change in Covid policy would be positive for metals. But China is still faced with issues including the housing bubble, slower manufacturing, reduced exports, looming labor and supply chain issues, and lingering public fears about Covid restrictions. We have a long way to go before China’s reopening will increase metals demand. 

The Aluminum Association reports that consumption in domestic markets through September of this year (demand less exports) increased 7.5% year-over-year. Spot prime aluminum was up 10 cents per pound over last month. The Midwest premium has leveled out at 20 cents per pound. Meanwhile, the consumers are in a year-end slow buying mode. Most prime aluminum scrap and secondary scrap was close to the same as October. 

Copper and nickel prices rose close to 10%. Stainless steel prices were up 25% on 304 and 15% on 316. Steel prices also rebounded slightly after seven consecutive down months. 

GOOD NEWS 

I am bullish on America because we are smart and creative. In August, President Biden signed into law a $200 billion boost to scientific research, which will become fully funded over the next several years. Some of this money will go to curiosity-driven people and projects, and the approval time will be weeks rather than many months. I believe there will be many new successful advances from the people and projects. Heidi Williams, a Stanford economist, said in a Wall Street Journal article: “Science is about taking risk, and that means many projects aren’t going to work. We should build a system for funding science that explicitly acknowledges and supports that.”  

Thank you for supporting Shapiro Metals in 2022, especially during such economically “interesting” times. We wish you happiness during the holiday season and into the new year! 

“There is no doubt that it is around the family and the home that all the greatest virtues, the most dominating virtues of humans, are created, strengthened, maintained.”  -Sir Winston Churchill 

Life is good. Family and health are precious.     

Bruce Shapiro     

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.