The daily yesterday was on the resiliency of the US economy. My overarching message was that the angst we are seeing in the market is not reflective of near-term economic strength. Instead, it’s a combination of worries about a slowing economy, slowing earnings growth and political uncertainty.
The real problem is capital investment. Look at housing
I wrote a market piece after markets closed yesterday too. And near the end of that piece, I wrote that “it’s big sectors of capital investment that I worry about – like housing and the oil patch. A fall in capital investment and employment there can take us from stall speed to recession relatively quickly in my view.”
And, of course, today, we got bad news on both fronts. First, we got poor residential construction data from the Census Bureau. When the Atlanta Fed released it’s updated Q4 GDPNow tracker, it said the following about the data:
The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2018 is 2.9 percent on December 18, down from 3.0 percent on December 14. The nowcast of fourth-quarter real residential investment growth decreased from -2.4 percent to -4.2 percent after this morning’s new residential construction release from the U.S. Census Bureau.
The 2.9% number is just fine, above stall speed, above the Fed’s long-run GDP ‘potential’ estimate and just about bang on the 3% the Trump Administration is aiming for. But the capital investment in new residential construction is falling. And it’s falling more than expected. So, it’s clear that the housing market is stalled and that the homebuilders are the first to take the pain on this. But, if the Fed continues to push up rates, we could see a wholesale stalling of the residential property sector. And that would negatively impact not just investment but also consumption.
Then there’s the oil patch
The sequence of events I pointed to yesterday started with the Taper Tantrum’s slowdown in EM metastasizing via commodities, particularly oil. The US is more vulnerable to external demand slowing because of the increase in shale oil production. The slowing of external demand causes oil stocks to rise and prices to fall. This is eventually followed by capital investment cuts and layoffs, once hedges are fully exhausted.
And we’re getting very close to that point now. WTI finished just below $50 a barrel yesterday. But, it continued to fall in trading today. The selloff today was massive. The last trade I see is for $46.55, which is a loss of over 7% on the day. Brent is at $56.31, with losses of over 5% on the day. If these levels hold throughout 2019, there will almost certainly be capex cuts among shale oil players in the US. And then we’ll have to see whether those cuts outweigh the consumer’s dividend from lower gas/petrol prices.
The reality is that the US is much more leveraged to oil now that shale oil producers are pumping out so much crude. So, when oil prices fall, we get less of a dividend from lower prices for consumers like an oil importing nation like Japan. Instead we feel a lot more pain from a slump in prices like, say, Canada.
Trump backs down, but the Fed is still in play
Yesterday, I ended my market piece saying, “I am looking to Wednesday and the Fed’s policy statement and Friday and the government shutdown standoff as keys to how the markets will develop over the next couple of weeks. Afterwards, it’s going to be more about the holiday sales numbers.”
As the day started today, the market tone was quite positive. The market opened up and the news that Trump was going to cave on the shutdown over the Border Wall reduced political uncertainty. But, oil weighed on the tone. And we still have the Fed to worry about tomorrow.
I am now anticipating a change in the Fed’s guidance and language, so stark has the downshift in financial conditions been. At a minimum, I expect the Fed to point to tightening financial conditions as a headwind. When Powell speaks after the FOMC statement, I would expect him to show bullishness on the near-term economy but caution on financial conditions. Ultimately, if the Fed doesn’t throw the market a bone, we could be in for a tough day tomorrow.