Weekly Market Update - October 6, 2016

Total Construction Put-in-Place (US Census Bureau): The CPIP data released on Monday showed that total (NSA) construction increased by 11.2% for the 12 months ending in August. Momentum was negative 6.6% because the 3 month y/y total construction value was lower than the 12 month number at +4.6%, (Table 1). On a rolling 12 month basis total construction has increased in each of the past 54 months, however momentum (3 month subtract 12 month), has been negative for 9 consecutive months indicating that construction activity is tapering off. Privately funded construction increased 15.3% y/y, and 9.0%, 3 months y/y, while State and Local rose 2.1% on an annual basis but fell to negative 5.2%, 3 months y/y.

Figure 1 charts total building construction from 2010 to present, illustrating the strong run it has had after the recession ended. The rate of growth measured as percent change y/y has declined over the past several months but remains positive. Single family residential (SFR), recorded strong percentage growth of 12.1% y/y, slowing to +6.9% on a 3 month y/y comparison.

Highways and streets saw a 3.8% y/y increase over the past 12 months, but posted a decline to negative 4.0%, 3 months y/y. All publicly funded project categories recorded negative momentum lead by sewage & waste at -11.2%.

Figure 2 charts total infrastructure expenditures from 2005 to present in non-seasonally adjusted, constant 2009 dollars. Expenditures have declined y/y in each of the last 5 months as has the percentage y/y change. On a 3 month y/y basis the percentage y/y change has been negative for 3 months in a row which is strong evidence that government spending on infrastructure is slowing after a 53 month consecutive run of growth. Data from the US Census Bureau shows that State & Local tax revenue declined y/y through Q2 2016 which explains the decline in infrastructure outlays as state & local governments strive to maintain balanced budgets.

Table 1

Figure 1

Non-Residential Construction continued to post growth, up 12.1% y/y, declining to 6.9% on a 3 month y/y basis. The private sector surged ahead by 15.4% y/y, declining to 11.0% growth on a 3 month y/y comparison. State and Local sector grew by a more modest 3.8% y/y, falling to a negative 2.9%, 3 months y/y, (Table 2). Education was the project category with the largest expenditure for the past 12 months at $95.8 Bn (NSA), up 6.7% y/y but falling to +1.5%, 3 months y/y. Manufacturing building construction has slowed to -4.4%, 3 month y/y growth rate after an 8.8% growth rate over the past 12 months.

Figure 3 shows that both the y/y percentage growth and spend rate on manufacturing buildings is starting to rise again after a sharp fall in late 2015, early 2016. Although the expenditure rate has picked up for five consecutive months and remains at an elevated level vs. history the percentage y/y growth continues to wane declining in each of the last 15 months, falling into negative territory for the past 3 months.

Figure 4 presents office building construction which is showing very strong growth, up 24.1% y/y. On a rolling 12 month basis, office construction has witnessed y/y percentage growth greater than 20% for 27 consecutive months. This is the first month where momentum fell into the negative zone, off 0.6%. Commercial buildings was the only project category to record positive momentum in August at +1.3%, having posted +9.5% growth, 4 months y/y and 8.1%, 12 months y/y. Expenditures have risen in each of the last 7 months and momentum has been positive for 59 months in a row.

Figure 5 overlays Dodge non-residential starts (a start is defined as all of the $ and square feet are counted in the month the project commenced), data for both square-feet and $ starts onto CPIP. In all cases the data charted is 12 MMA to smooth out volatility so we can clearly see trends. As discussed in last week’s Gerdau market update, both Dodge Square foot and $ starts have been showing declining starts for many consecutive months. The chart shows that CPIP has a much stronger relationship with Dodge square-feet than with Dodge $. However both Dodge starts data indicate that CPIP data should have started to decline by this point in time. Thus far CPIP shows no sign of slowing in expenditure terms. It does however show to be slowing on a percent y/y change basis, (Figure 6). Looking further back in history we can see a couple of occasions where the Dodge starts data and CPIP diverged for a period of time but in each case the relationship eventually was re-established.

Table 2

Figure 3

Figure 4

US GDP 2nd Q 2016 and Relationship to Steel Demand: The annualized GDP growth rate in the 3rd estimate of the 2nd quarter of 2016 was 1.41% which was slightly above the consensus expectation of 1.3% and an improvement from the 1st estimate which was 1.2%. GDP is measured and reported in chained 2009 dollars and in the 3rd estimate of Q2 was $16.583 trillion. The growth calculation is misleading because it takes the Q over Q change and multiplies by 4 to get an annualized rate. This makes the high quarters higher and the low quarters lower. Figure 7 clearly shows this effect. The blue line is the trailing 12 months growth and the black line is the headline quarterly result. Occasionally these measures coincide which was almost the case in the 2nd Q. On a trailing 12 month basis, GDP was 1.28% higher in the 2nd quarter of 2016 than it was in Q2 2015.

Figure 8 shows the headline quarterly results since 1990 and the latest IMF forecast through 2021. In their April revision, the IMF downgraded their forecast of US growth in 2016 from 2.84% to 2.4%. In their October 2016 forecast released this week the IMF further downgraded their expectations for US GDP growth in 2016 to 1.58% and 2017 from 2.5% to 2.2%.

Figure 9 shows the change in the major subcomponents of GDP in Q2 2016 and the dominance of personal consumption as a growth driver. The change in inventories was the greatest detractor with a contribution of negative 1.16%. Declining inventories have a negative effect on the overall GDP calculation and this has been the case for the last five quarters. Over the long run inventory changes are a wash and simply move growth from one period to another. When a decline in one period is subtracted from growth, it can often be a healthy indicator for future periods because it suggests that the lower levels of inventories will set the stage for added GDP growth in the future. Residential construction made a negative contribution in Q2 as non-residential which includes infrastructure made a small positive contribution. Net exports made a positive contribution in Q2 and added 0.18%. Figure 10 shows the breakdown of the $16.6 trillion economy.

Historically it has been necessary to have about a 2.5% growth in GDP to get any growth in steel demand as shown by the intersects in Figure 11 which gives the relationship between US domestic steel demand and the growth of GDP over a 70 year period. The situation in the first 7 months of 2016 is that demand is down by 10% from 2015 which is worse than history projects. This relationship is a long term average and in reality steel is much more volatile than GDP. If GDP takes a dive then steel demand craters and if GDP takes a sudden upturn steel soars. Neither of these extremes is evident at present. The latest results for GDP growth in Q2 2016 and the IMF forecast doesn’t suggest any improvement in the steel market in the immediate future.

Figure 7

Figure 8

Figure 9

ISM Manufacturing Index: The Institute for Supply Management’s manufacturing index for September rose to 51.5 from 49.4 in August. However on a 3MMA basis the index fell to 51.17 from 51.73 last month, (Figure 12). Two years ago the index stood at 56.87 (3MMA) and one year ago it was at 50.97. There was a six point gain in new orders to score a value of 55.1. This was encouraging, largely offsetting the slide that occurred in August. Despite an apparent increase in new order activity the employment sub-index recorded its third consecutive monthly score below 50 indicating that employers are not expanding payrolls.

The difference between new orders and inventories, which is considered a proxy for future production broadened from 0.1 in August to 5.6 in September. This indicates that we can expect to see increased production levels going into the fourth quarter and into 2017. Mining, agriculture and heavy equipment remains a drag on manufacturing, however gradually rising energy prices, supported by a recent OPEC deal, will likely revitalize U.S. producers over the coming year.

Moody’s forecasts that manufacturing industrial production will grow 1.7% at an annual rate in the fourth quarter and thinks that the latest ISM report does not “appreciably alter the risks to this forecast”. Moody’s goes on to say that it will take time for manufacturing to strengthen and that it expects that 2017 will be a better year.

Figure 12

ISM Non-Manufacturing Index: The non-manufacturing index surged to 57.1 in September. This 5.7 point gain was the largest gain since October 2015 and well above analyst expectations. On a 3MMA the index moved up 0.2 points to 54.7, (Figure 13). Business activity and new orders sub-indexes climbed above 60 as the employment sub-index rose to 57.2. The export orders sub-index gained 10 points to 56.5 and the inventories sub-index expanded 3.5 points to 51.5, all factors indicating solid growth. Note that the non-manufacturing sector accounts for 88% of US GDP. Strong growth in the non-manufacturing sector means the overall economy is solid and is an encouraging sign for future growth in long product steel demand.

The fundamentals are that both the housing market and consumer spending are gaining strength. Rising wage pressures will support further growth in consumer outlays in the coming months. In addition the tightening labor market will pull discouraged workers off the side lines which will further bolster consumer spending and strengthen government coffers.

Figure 13

US Steel Production (AISI): US steel production for the week ending October 1st totaled 1.611 million tons (Mt) as US mills operated at 68.9% of the total possible steel production capabilities. Steel production peaked in June and has declined steadily over the last four months, to its lowest level since January, (Figure 14).

Softening demand for durable goods was exacerbated by the glut of used heavy equipment for sale and high inventories of new equipment. Weakened demand for hot-rolled coil and other flat products was attributed to slowing automotive orders, as the surplus of 2016 model sales were in competition from lease dealer over supply of low mileage used vehicles. Additionally, slowing construction, manufacturing and weak exports have also contributed to US metal service centers’ early end of the year destocking, which historically takes place in late November.

Although steel imports have declined the last two of months, foreign unfairly traded steel continues to plague the US as well as European and other steel markets. US steel mills plan to file complaints with the Commerce Department alleging Chinese steelmakers have routed metal shipments through other countries in efforts to circumvent US import tariffs.

These unfavorable factors weighed on US steel output in all regions, with the exception of the Great Lakes, (Figure 15). Year to date US steel mills have produced an unrevised 67.364 Mt of steel, down 2.2% y/y.

Figure 14

Steel Demand Indicators: Table 3 is a snapshot of the market situation on 10/05/2016. Indicators updated since we last published two weeks ago are shaded beige. In most cases this is not September / October data but data that was released in those months for previous months, the actual month to which the data relates is shown in the second column. Of the 27 indicators under consideration, the present situation of 6 are positive by historical standards, 9 are negative and 12 are neutral. There was an increase of one positive and one negative since our last update on September 22nd, which resulted in an increase of two neutral. Our intent in using the word neutral is to say that this indicator is considered to be in the mid-range of historical data. Changes that occurred in the last month were as follows. On September 29th the Bureau of Economic Analysis released the 3rd estimate of the growth of GDP in the 2nd quarter. On a year on year basis, growth was 1.28% which was the lowest since Q2 2013 and caused us to reclassify this data point from neutral to negative. Consumer confidence was re-classified in the opposite direction from neutral to positive on the strength of the Conference Board report for September in which the three month moving average of the composite exceeded 100 for the first time since October last year. In the long steel product section the rebar import price CIF Houston was re-classified from neutral to negative. In the manufacturing section the ISM index was re-classified from positive to neutral as it fell below 52.0. There were no other changes in our view of the present situation.

In our trends analysis, most of the values reported are three month moving averages to avoid the knee jerk reactions that are characteristic of most economic reports in the press. Please note that there is nothing subjective about this trends analysis. The numbers presented here are the facts available as of October 5th 2016. The number of indicators trending positive in this latest analysis was 14 with 13 trending negative. This was a net increase of one negative since September 22nd.

In the general economy, all indicators are trending positive. This may seem to conflict with what we wrote about GDP above but the economy is still growing albeit at a rate that is not at the historical norm. In the long products section the trend of total supply reversed course and contracted. There were no changes in trends for the construction or manufacturing sections.

We have separated the leading indicators from the main table for a closer look, these are shown in Table 4. Of the twelve leading indicators nine are trending positive, and three negative. This was no change from our September 22nd update. In summary the present situation is historically weak but has improved slightly in the last two months. Trends have weakened in the last six months and at the end of September 51.9% of indicators were trending positive and 48.1% negative. This was the highest proportion trending negative since January. (Explanation of Indicators).

Table 3

Contributors this week include; Laura Remington, Peter Wright and Steve Murphy