Saturday, July 17, 2021

How Demand Outpaced Supply

Mr. Demand and Mr. Supply were constantly jogging along the Economic Trail.  Most of the time, they ran in tandem, at about the same speed. But sometimes Mr. Supply ran ahead of Mr. Demand and often the roles were reversed. But then, they would instinctively adjust their pace to get back into balance once again.



Mr. Price always accompanied Mr. Demand and Mr. Supply on the trail. Mr. Price could be unstable so instead of jogging he rode a bicycle. When Mr. Demand got ahead of Mr. Supply, Mr. Price would pedal faster to get ahead of Mr. Demand. Then he would force Mr. Demand to slow down so Mr. Supply could catch up to him. When Mr. Supply ran ahead of Mr. Demand, Mr. Price would drop back, causing Mr. Supply to slow down and Mr. Demand to speed up. In both circumstances, as soon as Mr. Demand and Mr. Supply were back in sync, Mr. Price could be found pedaling right beside them.

Everything was moving along fine on the Economic Trail until March of 2020 when both Mr. Demand and Mr. Supply were infected with COVID-19. Both guys immediately stopped and sat down on the trail  to recover. Fortunately, Mr. Demand had only a mild case of the virus. Soon he felt much better and started running again at a modest pace.  Unfortunately, Mr. Supply got much sicker from the virus. He lay weak and dormant for a couple months. He finally got up and tried to run but stumbled along at a slow pace.

Mr. Demand continued to recover and picked up the pace. His Uncle Donald even gave him some strong coffee to help his recovery. Mr. Demand was now running much faster than still sickly Mr. Supply, and the gap was widening. Mr. Price had also been infected but was asymptomatic. He had stopped on the trail, waiting for Mr. Demand and Mr. Supply to recover. He had followed Mr. Demand back on the trail and expected Mr. Supply to follow them, but he had not.

Now Mr. Price was pedaling faster but didn’t know quite what to do since Mr. Demand was not slowing down and wasn’t concerned at all that Mr. Supply was falling so far behind. The gap between Mr. Demand and Mr. Supply had not been this wide for many years.

Even though Mr. Demand appeared to be healthy, his Uncle Joe was concerned he was not running fast enough. So, Joe gave him an energy drink, a stimulus, to get him to run faster. But no one was concerned with the condition of Mr. Supply. Even though Mr. Supply was increasing his pace, Mr. Demand was still running much faster.

Uncle Joe was so happy that the first stimulus worked so well, he jolted Mr. Demand with a second energy drink. Now Mr. Demand was sprinting at top speed. However, even though Mr. Supply was trying to run faster, there were obstacles on the trail which slowed him down. He asked for people to work to help him run faster, but they were too distracted by Mr. Demand’s stimulus, to aid Mr. Supply. Others declined to help due to the persistence of the pandemic.  And some potential workers had left the trail altogether. He also needed a new pair of running shoes, but he couldn’t get them due to a shortage of silicon.

So, no matter how hard Mr. Supply tried to catch up, he could not, and Mr. Demand was now miles ahead of him. This motivated Mr. Price to pedal faster than he ever had since the 1980’s. He needed to get ahead of Mr. Demand and slow him down, so Mr. Supply could catch up. But he was pedaling so fast that his tires got overheated and are now highly inflated, and he fears a blowout, which could lead to a crash.

And so it goes ……


This post originally appeared in the FTR blog. For more information on FTR, the leader in commercial freight analysis and forecasting: FTRintel.com 


Saturday, April 24, 2021

Let The Roaring Twenties Begin!

In ’21, we see an economic recovery unlike never before. Of course, I am referring to 1921, after both WWI and the Spanish flu had ended. But the country's mood now, as vaccines work to end this pandemic, is beginning to rise toward a euphoric state.

This, combined with tremendous government stimulus efforts, has caused the demand for goods to skyrocket. The GDP forecasts for 2021 continue to move higher. FTR (Freight Transportation Research) forecasts 2021 GDP growth at 6.1%. In the latest Wall Street Journal survey of economists, the range is from 2.4 – 10.0%, with the average at 6.0%.

The ISM (Institute of Supply Management) Indexes, which are forward-looking, confirm there is robust demand present now and in the foreseeable future. The March Manufacturing PMI spiked almost four percentage points to 64.7, the highest reading in 37 years! IHS Markit’s Index placed it at the second-highest reading ever. Likewise, the Services PMI jumped over eight percentage points, to 63.7, an all-time high.

The economic shutdown in March-May 2020 created enormous pent-up demand in the economy. It produced a “sling-shot effect”, where commercial activity was held back and then propelled forward rapidly. Therefore, substantial pent-up demand built up during the economic lockdown and was unleashed in the restart.

However, there was no pent-up supply, rather the opposite, in fact. Factories shut down, during well, the shutdown. Unfortunately, the restarts in many industries have been difficult. Manufacturers had to install COVID safety protocols. Workers have been reluctant to return to jobs either based on personal health concerns or generous government assistance. The global supply chain was also impacted, resulting in huge backlogs at the ports. Throw in February’s polar vortex, and you get an unprecedented widespread shortage of components, parts, and industrial output.

The result is surging demand combined with pent-up demand, matched up against constricted supply. Of course, this creates more pent-up demand since manufacturing has still not caught up in the short term. Pent-up demand clouds the economic forecast because it is difficult to measure and determine how long it will take to catch up. However, the ISM numbers show it is massive and growing.

For an estimate of overall manufacturing pent-up demand, it appears that the current supply of Class 8 trucks is running about 20% behind demand. Truck manufacturing is being impacted by the shortage of semiconductors, but many industries are not. Therefore, let’s estimate the total pent-up demand in all manufacturing at 15%. Meaning the supply is running 15% below total demand. Combine this with the enormous pent-up demand in the service industries due to the pandemic, and the economy is set up to surge in the next 12 months.

When there is another pandemic, perhaps world governments should expand the definition of essential workers to include those industries that should not be shutdown because their products are essential to a restart. They could receive government loans to build inventory and quickly repay the loans when the


inventory sells.

If you never understood what the Roaring Twenties were, you are about to get a very personal history lesson. But whenever I make that statement, the comment I always hear is: Yes, but remember what followed the Roaring Twenties.

Well, advancements in medical intelligence and technology have enabled us to significantly limit the fatalities from COVID-19 versus the Spanish flu, on a population percentage basis. Let’s hope our knowledge in the field of economics has made similar advancements.

This post originally appeared in the FTR blog. For more information on FTR, the leader in commercial freight analysis and forecasting: FTRintel.com 

Sunday, March 14, 2021

Are the Fears Inflated?

You’ve probably seen the headlines about some economists becoming increasingly concerned about inflation. So, should we be concerned?  (Note: please keep reading. This is not one of those in-depth analysis involving T-bills and yield-curves, but more of a big picture, horse-sense type of view.)

Definitions

The most basic definition of inflation is: Too many dollars chasing too few goods.

A more precise definition from Investopedia:

“Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.” 

Some inflation can be good

Complicating Factors

Inflation is inherently challenging, because it means your money is worth less, because it can buy less goods or services. However, economists generally believe that a low, and steady, inflation rate of around 2% is good because it signifies a growing, healthy economy. Inflation, under control, does help to balance out imbalances in basic supply and prices.

We have not had to deal with high inflation for a long time. The last time inflation was above 5% was in 1990. The last time inflation was above 10% was 1980. The Clinton administration achieved strong economic growth, with low inflation, by significantly increasing imported low-priced goods from China. Economists labeled this strategy as “importing deflation”. This strategy worked so well it has been advanced by every administration since then, except for one.  But that’s a political discussion, and I’m not swimming in that pool.

The other factor limiting inflation has been technology, especially the tremendous efficiency benefits provided by the Internet. Technology and the efficiency it provides, lowers just about every type of cost, thus reducing inflation.

Current Situation

But let’s get back to this “Too many dollars chasing too few goods” thing. Why are economists concerned?

Too Many Dollars?

The government flooded the economy with cash in 2020 with the stimulus deals. This helped many people in financial distress, but many people received checks they didn’t need.  Consumers spent this windfall or saved the money for future purchases. And now, there is even more stimulus money on the way. From my point of view, there are too many dollars currently in circulation. This by itself might not be a problem, but...

Too Few Goods?

Ever since the economic restart, some goods were in short supply. The list included both consumer goods and industrial goods in an extensive range of industries. For example, there was a severe shortage of hotel towels in October, and some of those are produced in Pakistan. And now, there are reports of cat food shortages in some areas of the country.

While many of the shortages have been alleviated, some have intensified. We see the headlines for computer chips and steel, but we know in the commercial equipment industry that these products and a host of others are in short supply. The supply chain is in a mess. I’m guessing manufacturing material, and component shortages are in the worst shape since WWII.

So, we can’t make enough products to satisfy demand. Combine this with consumer products sitting on ships for days waiting to dock and then being delayed a few weeks due to port congestion, and you end up with too few goods. The inventory numbers confirm this.

What? – Me worry?

Federal Reserve Chairman Jerome Powell has finally admitted that he expects some inflationary pressure as the economy reopens but expects it to be temporary. Previously, he said he is not concerned because inflation doesn’t “change on a dime” and that a return to standard 2% inflation rates is not a danger. He also thinks the FED will be able to control the inflation once it starts.

In effect, he is saying they will be able to control the boulder once it begins to roll downhill.

What happens, however, if that boulder rolls right over the FED and anything else you put in its way. It’s like the old Chaka Chan and Rufus song: “Once you get started, oh it’s hard to stop”. Inflation isn’t something you want to see gaining speed quickly. 

Big Difference of Opinion

There are those economists sounding the alarm based on the factors previously cited and the movement in the 10-year treasury yield curves. But Chairman Powell and other economists in the Biden administration say “Move along, nothing to see here”. Of course, they can’t both be right. So, hope for the best, but be prepared for the worst.

This post originally appeared in the FTR blog. For more information on FTR, the leader in commercial freight analysis and forecasting: FTRintel.com 

 

Wednesday, February 24, 2021

If You Start Me Up - Restarting the Industrial Economy

 When the economy was in lockdown there was a strenuous debate on what would happen when the lockdown ended. One argument was the economy would stay in recession for months before gradually recovering. This view supported the case of preserving the lockdown since there was little benefit to opening back up. “You can’t just turn the economy back on like a light switch”, they claimed. The opposite view claimed that when the economy reopened, there would be a “V” shaped rebound, with the economy taking off like a rocket. This argument supported opening the economy up fully and immediately, despite the health risks.

As it turned out both sides were wrong, or at least only partially correct. After the fifty governors started reopening their state’s economies to one degree or another, economic activity jumped, but it wasn’t a capital “V” recovery. It was more like a lower case “v” recovery. This is because manufacturing has been lagging compared to the robust comeback in the consumer goods sector. When that proverbial light switch was turned on, the demand side of the consumer economy snapped right back, except for those contact-service industries. Demand also jumped on the industrial side but it is hard to gauge due to the

If you start it up!

supply factors discussed later.

Consumers who were able to maintain their income, spent heavily on goods and non-contact services. In many cases, they had even more disposable income due to government stimulus checks. It was relatively easy to restart the export goods pipeline, so easy the ports have been backed up for weeks as containers arrived.

Manufacturing Lags

It is much more difficult to jump start the industrial side of the economy. Factories were shut down for weeks. Some of these factories had never been idled except for a few days at the end of the year for holidays. There are startup and maintenance issues with some types of equipment. Workers need to be recalled, and material and parts inventories need to be replenished.

In addition, there were significant health factors involved in restarting the factories. Social distancing, disinfecting, contact tracing and quarantines all impacted productivity. Some workers declined returning to factory jobs due to personal or family health concerns. While many employees switched to working at home, this is not an option for production workers. There is also a major issue with government stimulus and extended state unemployment benefits providing a disincentive for reentering the workforce. In some states, the hourly unemployment benefit is close to or greater than the average factory wage. This is causing a severe worker shortage in certain industries.

There are also problems acquiring imported parts. Mexico remained on lockdown weeks after the U.S. restarted. Overseas producers rebooted more quickly, however; the U.S. ports were flooded with containers of restocking consumer goods. This is causing gridlock and delaying the delivery of key industrial components to manufactures for weeks.

All these problems resulted in a dysfunctional supply chain. There are steel, aluminum and wood shortages, among others. Even computer chips for autos and trucks are scarce. There are component shortages in many industries which are slowing production and raising prices. My sources tell me that the problems are intensifying in February, with no relief in sight. One manufacturing expert says “So the supply chain has basically dissolved.” It’s difficult to determine what the true demand is coming out of the lockdowns, but it is readily apparent that we have a supply chain quagmire, the likes of which this country has not experienced since WWII.

A Wide Gap Between Consumer Demand and Industrial Supply

The great disparity between the rebound in consumer market versus industrial is illustrated by comparing orders for van trailers, those hauling consumer goods, and those for flatbed trailers, used for transporting industrial goods. For the 2020 September-December time period, van orders were up an astounding 160% over the same period last year. Flatbed trailers were up only 31% (still respectable).

The good news is that flatbed orders have shown a noticeable improvement starting in November and are accelerating in 2021. The ISM PMI for manufacturing remains at high levels indicating that demand is strong for manufactured goods and is growing. Now supply just needs to catch up.

The Future for The Industrial Sector Looks Bright

The supply chain clog will be cleared at some point due to the laws of economics and the profit incentives of free markets. It could take an extended time since conditions are still worsening. The vaccine should lower infection rates and allow many people to return to the workforce, including factory jobs. Also, as state unemployment benefits run out, the job numbers could spike. This should drive down unemployment, and with the reopening of the travel and hospitality sectors, give a welcome boost to GDP.

This post originally appeared in the FTR blog. For more information on FTR, the leader in commercial freight analysis and forecasting: FTRintel.com

 

Tuesday, January 21, 2020

In 2020, 20K May Be The Key Number For Class 8 Trucks


The current state of the Class 8 truck market has fleets carefully evaluating their truck needs for the next few months and placing orders for delivery within that timeframe. OEMs can easily schedule production to deliver on time and suppliers are having few problems keeping pace.  The Class 8 market is currently operating as a normal industry, with demand and supply in close balance.


However, this situation is also highly abnormal, since Class 8 trucks are one of the most cyclical industries in the entire economy. When the freight market is growing, fleets must forecast how many trucks they will need in the future, sometimes as far as a year ahead, and order accordingly. When the freight market is receding, fleets must decide how many older units they can afford to replace, based on declining revenues, and reduce orders accordingly.

There have been a few years where production has been near replacement demand levels, estimated at around 240,000 units. Weak GDP and freight growth are typical during those years.  But there is still some cycling, as shipments start below replacement demand levels at the beginning of the year and then rise above them at the end. So the market still cycles, and doesn’t remain right at replacement levels for very long. Also, orders in these years tend to follow traditional trends as well, higher in Q4 and lower in Q3.

How We Got Here

Class 8 orders set a record at an astounding 497,000 units in 2018.  Freight growth surged in 2017 and kept on going in 2018. Fleets did not expect the jump in business and there was a shortage in trucking capacity. The ELD mandate reduced overall productivity, exacerbating an already bad situation.  Rates spiked as service levels tanked. Carriers desperately needed more trucks, but OEMs and suppliers ran out of manufacturing capacity, intensifying the shortages. As freight continued to grow, the big fleets began ordering for 2019 deliveries in the summer of 2018. Just under 53,000 orders were placed in July 2018, traditionally the weakest month of the year. This was followed by a record 53,300 orders placed in August. 

OEMs were able to find enough workers to ramp up build rates and suppliers resolved most of their issues, leading to production of over 340,000 trucks in 2019, a record for a year not impacted by an emissions mandate pre-buy.

Orders slowed significantly in 2019 because most of the orders for delivery in that year were placed between July and December (estimated at 225,000).  Orders in January – September 2019 averaged a paltry 13,300 units a month; volumes more likely seen during a recession even though economic growth continued. But you can’t evaluate 2019 orders without taking the record set in 2018 into account. You need to look at 2018-2019 together. Orders averaged 28,000 units a month over the two-year period. For 24 months orders were 40% over replacement demand level (20,000 units a month), fueling two terrific production years for Class 8 trucks. Freight growth stalled in 2019, but production remained robust for much longer than expected because total hauling capacity just caught up with freight volume.

The Great Reset Is Here

Fleets traditionally begin ordering for the following year in October. Under normal conditions, orders in the fourth quarter are the highest quarter by far. Large fleets evaluate their equipment needs for the following year in the summer and send their quantities and specifications out to the OEMs for pricing. They then place their requirement orders in Q4, often issuing orders out in a 12-month window. Medium-sized and smaller fleets often order in quantities based on what the big fleets do.

However, conditions this year are much different. The big fleets are determining what older trucks they are going to replace in Q1 and just placing orders for those. The rest of the market is following their lead and placing smaller orders for shorter delivery times. Q4 monthly orders were 22,000, 17,600, and 20,000, for an average of just under 20,000, which is equal to replacement demand. As mentioned before, this is consistent with many other industries in a low-growth environment, but what has caused this abrupt change in typical ordering patterns for Class 8 trucks?

Caution Reigns Supreme

This is not a poor business environment. Freight levels are high after a couple of years of vibrant growth. Rates took a hit from the high prices in 2018 but have started to recover some. There is plenty of freight to haul, so well-managed fleets will be profitable, as poor-manage fleets go bankrupt due to the slowing of freight growth. The economy keeps growing and a recession is unlikely in 2020. However, it is a highly uncertain environment, with much downside risk.

The key risk factors are:

-         The economy has slowed from its strong performance over the last couple of years. FTR forecasts GDP growth at 1.7% for 2020, down from 2.3% in 2019.

-         The industrial sector of the economy is weak. The ISM manufacturing index is at 46.8%, indicating manufacturing is contracting. The index is at its lowest level in ten years.

-         Class 8 truck loadings are expected to be basically flat in 2020, at a 0.9% growth rate.

-         There are continuing tariffs and trade wars. Yes, it does look like some conflicts are calming down, but one tweet can change everything in a moment.

-         Business investment in most sectors of the economy has pulled back due to this same uncertain environment.

-         There is a caustic political environment and there is an impeachment trial.

20K in 2020?

Under this highly uncertain environment, there is no speculative ordering of Class 8 trucks. This is like a mountain climber on shaky terrain. One careful step at a time. Orders are for only what is needed – out for one quarter at a time.

Usually, when the market hits equilibrium, where supply and demand are balanced, it doesn’t remain there for long, because demand is almost always cycling up or down. But this time is different. Uncertainty may even increase before it decreases because the upcoming election could be between candidates with starkly different business and economic philosophies. Throw in the possible conflict with Iran and the ledge gets even shakier.

Flat freight growth means fleets do not need to expand. A growing economy and high freight volumes enables them to replace old units with minimal risk. So, we are left with only replacement demand, estimated to be around 20,000 units a month. 

Therefore, the Class 8 market is in a holding pattern. Orders and build rates may stay locked in this range for a while. That means ironically, we are stuck in the 20,000-truck a month range in the year 2020. It could be the most stable Class 8 year ever.


Tuesday, December 17, 2019

The 2019 Class 8 Truck Market Was A Thriller


You could make a movie out of the dramatic Class 8 market in 2019. But it would be a terrible movie. And a movie we have watched before.

It Was the Best of Times

The movie begins with great joy in the industry. The freight surge in 2018
creates unprecedented demand for trucks (not counting the emissions pre-buy of 2006). OEMs are cranking out trucks as fast as possible. Suppliers are keeping up after disruptions in 2018. Dealers are finally getting stocks, and they are flying out the door. Fleets are putting the trucks into service, and profits rise. Factory workers, truck drivers, investors, and every industry stakeholder are happy, happy, happy.

But Then Things Change

By the end of the year, freight growth stalls. Fleets have enough trucks to handle the available freight. Production at the OEMs slows. There are layoffs at both the OEMs and suppliers. Trucker wages, especially owner-operators, fall. The weaker performing fleets go bankrupt. Fleets pull back on orders for next year due to the high degree of economic, trade, and political uncertainty. The industry people are all sad, and nervous about the future as the movie comes to a close at the end of December.

And We’ve Seen This Movie Before

The Class 8 truck market is one of the most cyclical industries in the entire economy. And while this downturn is similar to previous ones, it does have some unique features. The 2019 FTR forecast was for a robust first half of the year, a stepdown in Q3, and a further erosion in Q4.

The build in the first half of 2019 was even higher than our lofty numbers. I realized at the FTR June forecast meeting in mid-May, that something was amiss. We had the market softening in Q3, but there were no signs that production was slowing down much at all, a short six weeks prior to July. And Q3 did ease, a mere 3%, but at almost 93,000 units, it is still one of the top quarters in history.

But the inklings about a Q4 drop started in July. Fleet confidence started to fade as freight growth slowed. Spot rates dipped, as well as profits. OEM backlogs were plummeting due to lower orders and elevated cancellations, as fleets pulled orders out that they had placed many months ago. Supply of trucks was finally catching up with demand, which always happens, but this time it was more sudden. There was talk that OEMs were considering drastic Q4 cuts, even as Q3 production remained robust. I wondered aloud during an August meeting, “What are the OEMs going to do? Build like crazy for nine months and then just shut the whole thing down?” It sounded crazy when I said it, but it doesn’t sound crazy right now.

The Roller Coaster Was Wild This Time

We’ve experienced wild demand swings in the industry before, but nothing like this time. For example, in the last 12 months (December 2018 – November 2019) Class 8 orders have equaled 180,400. In the previous 12- month period (December 2017 – November 2018) orders were 513,500. And of course, the economic shock, the extreme outside factor, the black swan which cause this precipitous crater was, was, …. Oh yeah, there wasn’t one. This is just the cyclical nature of the Class 8 market.

Production is expected to drop around 30% from Q3 to Q4. Once again, the big economic hit is …… none. Although there are enough economic and environmental pressures present to increase uncertainty entering 2020:
-         GDP growth falling to 0.9% in Q1.

-         Freight growth of only around 0.5% for most of 2020

-         Manufacturing growth in decline for four straight months, probably headed for a “manufacturing recession” (six months or more under 50 ISM), similar to 2015-16.

-         Uncertainty due to trade wars, tariffs, etc.

-         Political turmoil in the news daily.

-         The upcoming 2020 election which will slow business investment as the day approaches. The expected contrast in business philosophy between the candidates will amplify this effect.

Recession Talk?

Several months ago, there were many economists raising the possibility of a recession in 2020. There wasn’t much support for these forecasts and that talk died down quickly, with the general consensus being no recession is imminent.

However, I think there is a better recession argument to be made now based on the factors listed above. Also, the Class 8 market is a leading indicator, and the order numbers for October and November do signal possible trouble. I don’t think a recession is coming in 2020, but the conditions are similar to 2016 when economic growth nearly stalled out. It would not take much of a bigger dip or an outside force to push the economy under water for a short period.

Based on October and November orders, it appears Q1 production will start off weak. If manufacturing begins to recover in February, it will stabilize the Class 8 market and orders will improve. Hopefully, the 2020 version of the movie is not a horror film.

Tuesday, October 22, 2019

What is the Trade War’s Impact on U.S Manufacturing?


(This post appeared on my work blog in early October. Just a few days later there was progress on the trade talks. Conclusion? Both Trump and the Chinese read my blog!)

I regret to inform you that we are involved in a trade war. I regret it, because months ago I told my colleagues to calm down, proclaiming there would be no trade war. I believed that both China and the U.S. realized that a trade war would be too damaging to both countries and, therefore, they would strike some sort of deal. I even replaced the term “trade war” with “trade conflict” in our company reports, when the countries were just in the threatening stages. I don’t even like the term. It’s not like it’s a real war, but that’s the term we use. So, I admit it: I was wrong, so wrong.

What impact is this “war” having? When it began, the media went into panic mode, warning that the economy would be severely affected, with some even predicting a repeat of the Great Recession. That hasn’t happened yet because most journalists do not understand economics. Economics is basically the study of how people react to changes in order to maximize their benefit. Most dire predictions about the economy assume that people, and companies, will not change their behavior due to the tariffs. And this is absolutely false. People and companies adapt and make choices based on the new supply and prices of goods. Therefore, it is almost impossible to predict the impact of the tariffs as they are happening.

The business response to tariffs can be complicated. Take the real case of a component supplier to the commercial vehicle industry facing a 25% tariff on goods produced at their China factory. If you assume all costs get passed on, the product cost rises by 25%. They raise their price by 25%, which means truck and trailer OEM’s raise their prices to the dealers, who raise their price to the fleets, who charge more in freight rates, which results in higher prices to consumers.

However, this supplier, in this case, shifted its production to Vietnam, resulting in just a 15% increase in costs. But the changes didn’t stop there. Aftermarket customers balked at buying products from the new Vietnamese factory until the quality could be proven, leading the company to increase production at its U.S. factory. The supplier was also limited in how much it could raise prices due to market competition. So, the company is making less profit on roughly the same amount of sales, and there is minimal impact on down the supply chain. While less profit is not good, it is not catastrophic to the economy.

Also, I recently read an article about the effects of the tariffs on a company that produces a consumable sporting goods product in China. The company had achieved a dominant market share by utilizing cheap Chinese labor to slash costs. It could then price its product under the competition, and yet still achieve a higher margin. Now, due to the tariffs, its cost is more than the competition, and it can’t raise prices due to the competitive nature of the market. The company officer was whining excessively about how the tariffs were eating into his profits. Pardon me, but it was your decision to produce in China, which provided enormous profits and allowed you to crush the competition. And now you are complaining that your profits are no longer enormous. I just can’t feel any pity here. But this company is absorbing all the impacts of the tariffs, and I am not paying a penny more for this item at the store.

But the tariffs are having an impact. The farmers and other “targeted” industries are obviously suffering. It should be noted that these sectors are hurting as a result of Chinese actions. Instead of negotiating a deal, the Chinese choose retaliatory, targeted tariffs. However, I am not going to debate the merits or hazards of this trade war here. But how are the tariffs impacting the economy?

Two areas where the tariffs are causing problems are construction and manufacturing. Total Construction Spending was up just 0.1% in August, and June’s and July’s tepid numbers were revised downward. Year-to-date spending is down 2.3% versus the same period in 2018. How do tariffs impact construction spending? The tariffs increase economic uncertainty, and this decreases business investment. Business investment is an important element to overall economic growth, and obviously essential to the construction market.

Manufacturing is also displaying weaker numbers. The ISM (Purchasing Managers) Index for manufacturing was 47.8 in September, the lowest value since 2009. It has been below 50 (indicating manufacturing activity is contracting) for two months in a row. However, the index had been declining before the heavy tariffs kicked in, so what is the impact of the tariffs alone?

Let’s compare the last time the ISM index cycled down in August 2015, with this cycle in which began in August 18 (see graph). The ISM in this cycle was stronger until we hit May 2019. And in August the downward slope of the line increased. Therefore, a rough estimate of the impact of the tariffs on manufacturing is the yellow area on the graph. It indicates the tariffs began having a noticeable effect in May and it intensified in August.














The economic data from China is even more dire, with a report indicating China’s economy is growing at its slowest pace in 27 years. I may have been wrong about if a trade war would start, but I was correct about the impact to both countries.

Therefore, this conflict needs to end soon. The uncertainty is beginning to choke the economy, which would still be doing surprisingly well without this anchor. We may be on our way to a manufacturing recession (in my book, it takes six months at an ISM of 50 or below, and we are currently at two). If China’s GDP can recover, it helps the world economy, which leads to more U.S. exports.

There is still a lot of money sitting on the sidelines, waiting out the war. As soon as economic peace is established, this cash will come pouring back into the economy, providing a temporary boost. Which is exactly what we need right now.