Signals of slowing

Today’s post is going to be a bit of a hodge podge because I didn’t have a single theme to report on as I started out. If I had to give this post a title, the overarching theme would be “signals of slowing”. What I am seeing is nothing to be alarmed about per se. However, we should be cognizant that these signals are in contradiction to Fed policy tightening, which acting with a lag, makes yet more slowing possible.

Before I get to the economic signals of slowing, let me talk at length about the Paris attack and say that I believe that the terrorist threat in Europe and North America could negatively impact the economy under certain circumstances. I talked about this last night on Boom Bust (video clip here). The long and short here is that the increased security and vigilance is a drag on growth and in a stall speed situation, it could be an additional risk for the periphery.

Where did the terrorists come from? Here’s my educated guess. Many of them are homegrown. They are individuals who – because of lack of opportunity – have been radicalized. And as a result, they have gone to places like Syria where they have trained. I suspect that the Syrian passport found in Paris near the suicide bomber was left by him on purpose in order to sow seeds of mistrust regarding the incoming refugee wave. At the same time, it is very possible that this passport – which many believe is a forgery, especially as another with identical details and a different photo has been located in Eastern Europe – was used to re-enter the EU by the radicalized homegrown jihadists who had trained in Syria. We just don’t know yet. But the possibility will be enough to significantly boost security apparatus throughout the Schengen area and make us question what the economic effects will be.

Let’s put it this way: With France’s call yesterday to clamp down on border checks, we have entered a new era in the refugee crisis in Europe. Where before the costs were in dealing directly with the migrants themselves, today there are security, trade and transportation questions that are popping up. In a worst case scenario, the introduction of the additional friction associated with these border controls will decrease European competitiveness – particularly in the perphery – and add hundreds of millions of dollars in costs for every single member of the Schengen area. And a stall speed Europe needs growth more than anything else.

Which areas of the economy should we be looking at to determine winners and losers? The first place is transportation as ¾ of all trade of goods within the EU is done via roads and not rail. Border controls will impact this. When a truck driver is stuck at a border crossing, that’s paid work time. And then the question becomes who pays for that delay. As it stands now transportation companies have been paying. But they run on razor-thin margins at times. And it is only a matter of time before they pass on the costs to their customers who then pass on the costs to end consumers. One study showed increased costs of $600 million per year to the Netherlands alone just from increasing border wait times by one hour.

The next group to get hit is tourism. We are already seeing tourism take a hit. But to the degree we see further attacks in the EU, expect people to stay closer to home. That’s especially bad news to economies that depend on tourists like Greece or where record numbers of tourists go like France, Italy and Spain. A country like the UK would come out relatively unscathed give that it already maintains border controls. For the periphery this could be a big hit to competitiveness, making success in the whole internal devaluation/austerity game plan that much more difficult to achieve. As trade is already slowing, this would be in line with a de-globalization trend that is gathering pace. And for Europe, where growth has been weak, it is a drag on GDP hat will not be needed.

Winners? Security, defense. The European arms industry had faced problems from the declining demand for defense projects, according to the Stockholm International Peace Research Institute. From 2005 to 2014, defense budgets in Western and Central Europe fell by 8.3% in real terms, according to SIPRI. Companies like Finmeccanica will win out. For example, already in its 2013 annual report, Italy’s Finmeccanica, said that rising demand for border security and surveillance has been offsetting losses in traditional military orders. Other companies that could be winners: BAE Systems, France’s Thales, and European multinational Airbus, formerly EADS plus Boeing and other American defense contractors potentially.

Other signs of slowing that I am concerned with are in China, the US and in the tech market. Albert Edwards at SocGen had a good piece out today about the divergence in credit demand and credit supply in China, saying that as the bad loans pile up the demand side is showing weakness despite government efforts to keep the supply side going. If this is true, we would need to see demand side support from the government in the form of stimulus to offset private sector demand growth weakness – or we are going to see China weaken further. Anyone following this story has to think this is negative for industrial commodities and oil and by extension for the credit complex around shale oil in the US, despite the credit lifeline those companies have been handed.

Over at the FT, coming from a view that is more upbeat than Albert on the ability of government to do something about the slowdown, Gavyn Davies is talking about China as the new Japan. He sees the approach to monetary policy, given the downside risks to the economy, as “passive” and believes that the longer the Chinese stay passive, the more difficult things will get. The fact that Gavyn sees downside risks mounting too should give you pause regarding the incipient Chinese rebound meme that is making the rounds. Let’s wait and see.

In the US, the jobless claims numbers have ticked up enough to cause me concern. I told you a couple of weeks ago that these were the last unabashedly bullish numbers on the US macro economy out there, with nary a blemish to the downside. Well, that’s no longer the case. We are above 270,000 initial claims for the third week in a row. And while that’s a relatively good number, it is higher than it had been. We need to be watching this number because I believe higher claims will be a very important confirmation of slowing in the US just as the Fed is getting set to raise rates.

Finally, I think it’s interesting that also as these rate rises are coming online that the frothiest parts of the market are showing weakness. For example, Square is pricing its IPO below its latest funding round valuation. A lot of people have remarked on this. But what is additionally interesting is that the IPO price is also below the target range set by the bookrunners of this deal. That shows weakness that is causing companies like LoanDepot to postpone their IPOs.

Note as well that Fidelity is marking down the value of its pre-IPO mutual fund investments. This – in conjunction with the IPO weakness – is a sign that the froth in the pre-IPO universe has reached an apogee. Look at this as a marker for weakness on the market side of things.

The conclusion here has to be that there are signs of slowing that are mounting. They are not alarming yet but they are inconsistent with the Fed’s position of hiking rates. And to the degree the Fed’s tightening of policy is negative for risk with a lag, we should expect further economic slowing, especially in higher risk credit and equity markets.