Weekly Market Update - March 31, 2016

GDP 4th Quarter, 3rd Estimate: The final quarter of 2015 was a weak one despite being revised up to 1.4% from the initial 0.7%, 1st estimate and 1.0%, 2nd estimate, (Fig. 1). The increase was largely attributed to a higher level of consumer spending which accounts for about 68% of total GDP. Dragging down Q4 growth were poor exports and high inventory levels. Breaking down the six broad contributors to Q4 GDP; Personal consumption +1.66%, Fixed non-residential investment -0.27%, Fixed residential investment +0.33%, Inventories -0.22%, Net exports -0.14% and Government spending +0.14%, (Fig. 2).

The increase in consumer spending helped to offset the decline in manufacturing. The trio of strong dollar, low oil prices and unsettled financial markets was a drag on the economy resulting in reduced prospects for growth in 2016. Despite these factors, the economy continues to create jobs, averaging over 200,000 per month (2.7 million in 2015, 3.0 million in 2014), with remaining labor slack quickly getting absorbed. In addition vehicle sales are at record highs and with the average vehicle age on the road at 11+ years continued strength can be expected. Housing sales and new home construction are gaining strength with help from continued low interest rates. Business spending is on the mend notwithstanding the meager energy sector and government spending is strengthening after many years of restraint.

Looking forward, the IMF forecast 2016 to average 2.6% for the year with individual annualized quarters at: Q1 2.2%, Q2 2.5%, Q3 2.8% and Q4 2.8%, (Fig. 1).

Fig 1

Fig 2

Chinese Steel Report: In November 2008 the State Council of the People’s Republic of China announced a $586 billion stimulus package; an attempt to soften the effect of the global financial crisis. The State Council pledged to invest in infrastructure and social welfare by the end of 2010. This was a boost to domestic steel consumption. Early 2009 China’s Central Bank pegged the yuan to the $US dollar in an effort to stabilize the economy during the global financial crisis, (Fig. 3). Even as economic slowing was felt in the Europe and the US, China continued to depend on its export focused economy, achieving 10% growth. Once domestic stimulus projects wrapped up, steel demand waned, China’s domestic steel prices began to decline, and continued until the last week of 2015.

Upon announcement of the new currency regime, China’s Central Bank shocked global markets on August 11th 2015 by devaluating the yuan for the first time in two decades, which caused currency gyrations around the world. The People’s Bank of China announced it was moving to a more market-based system, where the yuan’s exchange rate would be determined by a basket of currencies. PBOC de-pegged from the $US as 2015 came to a close, setting the tone for the Yuan to track a broader basket of currencies. However, as reported by Dow Jones Business News in January, China quietly decoupled the yuan from its basket of currencies and re-pegged to the $US in the hopes of riding out short term fluctuations in global markets, allowing a slow supplementary devaluation of the yuan.

The yuan coupled with the $US dollar, combined with reduced steel production during the New Year holiday supported increased domestic prices, (Fig. 4). For the week ending March 9th, steel mills in Shanghai increased domestic steel prices by 20. Mid-March billet prices also rose, as Chinese billet suppliers, who demanded higher prices, defaulted on Southeast Asian shipments, stranding an estimated 1 million metric tons of cargo. On March 17th, in the wake of declining exports and contraction of domestic demand, the China Iron and Steel Association expressed “that sharp rise or drop of steel prices were not favorable for steel plants’ operation, advising steel plants to wait out recent market changes and to not expand production blindly.” China’s steel production peaked in 2014, reaching 823 mmt, more than the rest of the world combined. Chinese President Xi Jinpeng was quoted in October that China was committed to eliminating surplus steel capacity, and over the last six months has eliminated 90 million metric tons (mmt) of production. Steel plants such as Fufeng outside of Tangshan and other steel mills in the Hebei province, have cut capacity in advance of the Tangshan Horticulture event, as mandated by the state. CISA proposed additional 150 mmt in production cuts, to occur over the next five years. CISA deputy secretary-general stressed more cuts are needed in 2016, and more will be needed over the long term. President Xi echoed this when he told UK reporters, “China has been trimming outdated capacity, but up to now it has been using a scalpel when it should have been wielding an ax.”

Fig 3

Fig 4

Commercial Property Price Index: After climbing for 70 consecutive months, the CPPI has fallen for two consecutive months, yet still remains up 13.2% on a y/y basis, (Fig. 5). Referencing a March 23rd article in the WSJ, it is likely that the index will see further declines going forward. Commercial properties prices plummeted in February while total sales volume fell 46% million y/y to $25.1 million. Turmoil in the corporate bond market found its way into the Commercial Mortgage Backed Securities (CMBS) market in the second half of 2015, raising the cost of debt. CMBS lenders pulled back in 2015 capturing only 16% of the market after owing 27% the prior year. Bank lenders increased its market share taking up the slack. Despite the change in financing activity, the Federal Reserve suggests that the market is not a worsening in debt liquidity. Global equity markets still look to the US for relative safe yield in US commercial real estate. The commercial real estate market remains much healthier than it was in 2008 and February’s dip does not necessarily trigger an end to the bull market.

The architectural billings index (ABI) also includes a sub-index for commercial property. Recall that the ABI is a diffusion index and that >50 equates to expanding demand for design services, while <50 indicates waning demand for architectural design. Overlaying the commercial ABI onto the CPPI (both 3MMA) and shifting the commercial ABI 12 months forward we get the chart shown in Fig. 6. The total series correlation coefficient (CC) is 0.654 from January 2002 to December 2015. From January 2002 to December 2012 the CC jumps to 0.783. From this reference the commercial ABI appears to be a fairly good predictor of future CPPI. This relationship falls apart from 2012 to present (CC = 0.064) suggesting that commercial property prices may have got ahead of themselves. Still the main driver for commercial prices is net operating income which is strongly influenced by interest rates. Interest rates have remained very low by historical standards, however it is probable that they will increase over the near term.

Fig 5

Joist Shipments Report: Joist shipments got off to a strong start in 2016. Over the past two months ending February, combined shipments grew by 21.5%, (Fig. 7). Bookings over the same two months were up 18,496 tons or 15.0% y/y. This data indicates continued strength in the sector of non-residential construction that employs bar joists.

Fig 7

Consumer Confidence: The Conference Board Consumer Confidence index rose modestly in March. On a 3MMA the present situation score was 113.5, up 2% y/y. However the expectation index was 84.7, falling 12% y/y. Plans to buy a vehicle within the next six months were off 1.6 points, home purchase plans held steady, while plans to purchase major appliances purchase grew by 3.8 points to 51.1. The strong US dollar has fueled purchasing power giving rise to relatively low priced imported goods. However, consumers remain troubled by the volatility in the financial markets. Overall consumer confidence remains strong when compared to the rest of the post-recession period but it has waned from its highs recorded last year, (Fig. 8).

Fig 8

Advance Durable Goods Orders are showing that U.S. manufacturers are struggling. New orders for durable goods fell 2.8% m/m, however the picture looks better when examined on a 3MMA y/y basis orders were up 0.3%, (Fig. 9). Volatile aircraft orders dropped 27.1% after recording strong gains last month. Motor vehicles and parts continue to perform well, up 1.2%, its fourth month in a row of improvement. When the transportation sector is excluded, orders fell 1% after rising 1.2% in January. Among manufacturing industries, there were no increases in new orders. New orders for machinery slipped 1.3%, and the January number was revised lower. Durable goods inventories fell 0.3% after declining 0.2% in January bringing the inventory-to-sales ratio down by 0.1 point to 1.65. Fig. 10 shows the y/y percentage change in durable goods orders on a seasonally adjusted basis, illustrating just how volatile the results can be. In 2015 y/y growth was negative for most of the year. The good news is that so far in 2016, the y/y numbers are positive.

Strong headwinds continue for US factories. The dollar remains strong, although it has weakened somewhat since the beginning of the year. This coupled with anemic overseas growth is weighing heavily on US manufacturing. On a positive note, the ISM February orders held steady indicating that the current weakness may be temporary.

Fig 9

Market Trends for Steel Long Products: Twice each month in this report we publish our findings on the present situation of the long products market and where it is headed. We also keep track of how these two data sets are changing over time and we compare to the situation in August 2008, just before our businesses went off the recessionary cliff.

Based on the data released in March we have good news about where the market seems to be headed. Fig. 11 shows the trend of our present situation analysis, monthly since January 2010. Our view of the present situation progressively deteriorated from January last year through February this year by which time we regarded only 7 of 26 indicators as being historically good. This deterioration did not translate into a major increase in negatives, rather the number of indicators that we regarded as historically normal took up most of the change. In other words things were just ho-hum and not terrible. The more important aspect of this analysis for corporate management is where the situation is headed. Fig. 12 shows the trend of the trends also since January 2010. There is nothing subjective about the trend numbers, these are facts released in each month and the change in those values. The number of indicators trending positive peaked at 85.2% in August of 2014 with 11.1% trending negative and one indicator unchanged. There was a gradual deterioration through January this year by which time negative trends exceeded positives in the ratio 46.2% to 53.8%. This was the worst result in over 3 ½ years. February this year saw a small improvement but in March the number of indicators trending positive surged to 65.4%. We regard this data analysis as relatively stable therefore it looks likely that a positive change is really happening. It’s worth noting that at no time since January 2010 have we ever come close to the trend situation that existed before the crash in 2008. We really should have seen that coming but few did.

Fig 11

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