Webinar: Now What? The Economy in 2022 and Beyond

Here is the transcript from the webinar:

Tom Barrett:

Welcome everyone to our presentation today, The Economy in 2022 and Beyond with Dr. Chris Kuehl. If you follow the financial press, the conventional wisdom has come to to the simple conclusion that the way to fight inflation is raising interest rates. Unfortunately, this is not true. Yes, raising rates may slow the economy, but that alone won’t fix the inflation. And now I’m pleased to introduce Dr. Chris Kuehl. Dr. Kuehl is a managing director of Armada Corporate Intelligence, one of the co-founders of the company in 1999. He’s been Armada’s economic analyst and has worked with a wide variety of private clients and professional associations over the last 10 years. He is the Chief Economist for the National Association of Credit Management, and is on the board of advisors for their global division. He also makes close to 100 presentations each year, and I think you’ll find this presentation informative and educational. Chris has a doctorate in political economics and advanced degrees in Soviet studies and Asian studies. He was also a professor of international economics and finance for over 15 years. I’m sure you’ll find this presentation informative. Let’s give Dr. Kuehl a warm welcome by typing your location into the chat window you’ll find at the bottom of the screen. Dr. Kuehl, welcome.

Dr. Chris Kuehl:

All right, thank you very much. So your opening comment about the consensus among economists always makes me laugh because one of the jokes about economists is that if you put six of us in a room, you’re gonna get six different opinions – seven if one’s from Harvard. My favorite definition of an economist is someone who explains tomorrow why the predictions they made yesterday didn’t come true today. So we’re going to talk a little bit about what we think we know, what we know we don’t know, and what we wish we knew this morning. I was trying to get a little bit of a feel for what happened on election day, and of course we don’t really know. It’s gonna be another few weeks, if not months, before we know for sure. But we’ll talk a little bit about some of the implications of the election as well as the different versions of the future.

So if you have been following my profession, and one would wonder why you would, there is such a lot of variability in terms of what people expect. We’ve got those who are very much in the glass half empty category who really think that we’re in the midst of a recession now. And then you’ve got those who are pretty much the glass half full crowd that says, “No, we’re not in a recession now, may not even hit one next year.” So we’re gonna go into a little bit of why there is such variability because it’s a complicated subject. One of the things that I try to avoid doing is getting into media bashing because it’s a tough job, but the challenge is that the media is trying to take a very, very complex subject and break it down into soundbites. And that’s really, really hard, particularly when you’re talking about the economy because there are so many different variables at work.

So without any further ado, we’ll get into one of the first issues, if I can get this one popping up. If you were paying attention to economic forecasting the last few months, we had looked at the beginning of the year and thought that we had a pretty good handle on what was gonna happen through the rest of 22. We had two quarters of negative GDP growth, and when you remember when that was first discussed, it was immediately pounced upon as definitive proof that we are in a recession. That isn’t true. The fact is that GDP performance is one of 26 variables that the National Bureau of Economic Research uses to determine if you have been in a recession, NBE will never say you’re in one. It will never predict that you’re going into one. It will only tell you that you have been in one because it will look backwards at the data and determine what was going on.

One of the things they look at is GDP performance, but there are 25 other variables. They look at capacity utilization and they look at industrial production and capital spending and employment and quit rate and on and on and on. Many of those are not really pointing in a particularly bad direction right now. Many of them have slowed, but not to the point of even real concern. Others have crashed. And so it’s kind of adding to the confusion of whether we are or are not in economic distress. We expected quarter three to be very anemic. We thought we would see a little bit of growth, but nothing to write home about maybe 0.3 0.5%. Instead, we see growth between 2.4 and 2.6. So one of the questions is what the heck happened to see growth bounce back so dramatically in quarter three and is that a harbinger of things to come or is it an anomaly?

Right now we’re still seeing relatively unpleasant predictions for the next couple of quarters that we would see another down quarter in quarter four, and that would continue into the first quarter of 23. The good news, however, is that if these predictions hold, you begin to see a pretty substantial turn in 2023 by the time you get into quarter three, quarter four we’re back to growth. That would be considered normal for the last 20, 25 years. So the question is, what happened in quarter three? Why did we see that decline? Predominantly it was driven by trade and one of the things that has been playing a role all year long has been the value of the dollar. The dollar has been very strong, not necessarily because there’s anything particularly remarkable about our economic performance. It really comes down to the fact that the Fed was raising rates more aggressively and earlier than most other central banks.

So for a while, the dollar was responding to that interest rate increase more than other currencies were because their central banks weren’t raising. Now those other central banks are raising their rates and actually more aggressively than we are. If you look at the latest comments from, for example, the European Central Bank, the Fed is currently talking about what they consider to be a dovish pivot. They are kind of introducing the notion that this may be the last big rate increase, that this last three quarter of percent increase is the peak, and if they do anything from this point forward, it’s going to be more modest, maybe even as small as a quarter point. Maybe they’re done raising rates altogether. Meanwhile, the European Central Bank is suddenly becoming the aggressive one saying, “We have no intention of taking our foot off the break. We are going to continue to raise rates. We were slow to get into it, but by golly we’re gonna basically make up for lost time.”

What this has done is push the value of the Euro up even as the dollar stays strong. So it’s not that the dollar is weakening, it’s just that the other currencies are starting to catch up. Where that happens and how it happens affects trade, and this is when I go my standard rant about how we don’t understand manufacturing in the United States. We are still a major manufacturing nation. We account for 40% of the value of global manufacturing. China accounts for around 15 to 20%. That varies from year to year a little bit, but the percentages remain about the same. We manufacture very, very expensive things. We make airplanes and road building equipment and super computers and railroad engines. We are not in the business of producing consumer goods.

China beats us to death when it comes to volume because China is the country that provides what we buy in Walmart. We are the ones making the machines the Chinese are using to bank stuff from Walmart. So our export is much more sensitive to dollar value than other countries because if you’re buying something really expensive, you’re gonna wait for it to be cheaper. And so a lot of the countries that would normally be buying our high value stuff looked at the value of the dollar and said, “Look, it’s not gonna stay this high forever. Everybody else is gonna catch up. We know why the dollar is strong. We’re just gonna wait until our currencies are a little bit stronger,” which they were in the third quarter. So suddenly we started seeing a lot more export activity at the same time that we saw less imports because those prices were not as advantageous as they had been.

So the question then is, is this sudden growth in Q3 going to change anything as far as Fed strategy? It’s unlikely the Fed is fully aware of the fact that this is kind of a one trick pony. This is something driven by exports. It doesn’t reflect what’s going on with consumers, et cetera. So it’s not likely that this is going to presage any dramatic difference of opinion when amongst the Fed, but it begins to set up this notion that 2023 gets a little bit more cooperative than this last year. One of the things that we’ll kind of talk through as we go through this is the different motivations for inflation. And right now we’re kinda looking at four with maybe a lingering fifth, and I don’t wanna go into a rehash of your Econ 101 class, which I’m sure you all were terribly enthralled by and it was your favorite class in college and you just wish you could go back to those wonderful days of Monday, Wednesday, Friday, eight o’clock in the morning, macro econ.

But one of the things you might remember is that there’s two kinds of inflation. There’s demand to pull and cost to push. The only thing the Fed is really set up to deal with is demand pull because all the Fed can do is try to draw money out of the economy and they can do that only indirectly anyway. The Fed funds rate is the rate that they change, and that rate is literally just the rate that banks charge each other on overnight loans. So all the other loans, prime rate and car loans and mortgages and all the rest of that stuff, those all kind of follow from that original Fed funds rate. But not automatically. There’s banks have leeway to do what they wanna do, blah, blah, blah. So when the Fed is trying to draw money out of the economy, it is assuming that the reason for the inflation is that there’s too much demand.

The demand is overwhelmed. The supplier’s ability to meet that demand and the suppliers really have only two choices. They can either not produce at all and just deal with the fact that there’s too much demand or more commonly they raise their prices. They are trying to control demand by raising prices, they’re eliminating a certain number of consumers who are not willing to pay the higher price and the higher price provides an incentive for the producers to produce more. If the price is going up, it’s like, well, okay, the price is going up. It justifies my adding equipment, adding people doing whatever I have to do to increase capacity. But the inflation we’re dealing with now is more cost push. It’s being driven by one of those four factors, which is the collapse of the supply chain. It’s not that demand has been excessive, it’s just that the suppliers have not been able to meet it because the supply chain has been in disarray.

So you have normal demand, nothing out of the ordinary, but you can’t meet it anyway because what you were expecting to get from Asia or from elsewhere, you’re not getting. So that’s one of the drivers of inflation that we’ve seen really all year. And if you wanna be honest, two or three years back, another driver more recently is oil, which is what this chart is looking at. So we know we’ve had an energy crisis. We know that the price per barrel of oil jumped when all of the excitement started in Ukraine. As mentioned in the introduction, I actually have a background in Soviet and East European studies. That was what I planned to do with my life in the 1980s that was going to be a spook and study the evil empire and learned Russian and got a degree in Soviet studies. I was all set and then of course I went out of business in the middle of my PhD.

So now I metamorphize into a different kind of economist, but that Ukraine invasion skewed the oil world because we impose sanctions. You can’t basically lock out the second largest oil producer in the world and not expect a rebound. So that’s factor number two. Factor number three, which is basically begun to emerge in more dramatic form this year, but has been with us for a long time, is wages. And this is another opportunity for me to rant particularly about the political culture. For the last several weeks as we’ve enjoyed the election season, we have heard politician after politician talking about inflation and pointing fingers at the other party saying, “You’ve done this and you haven’t done that.” The reality is that Congress can do very little, if anything, to deal with inflation. They can if they’re anticipatory, if they’ve been thinking about it for years. But of course we know that politicians don’t think about much of anything for many years in a row.

The worker’s shortage is a lot of what’s driven, the high wages that we’re dealing with now. And this is not something that’s new and it’s not something that was unanticipated. What drives me nuts is that you’ve got the fact that 28 to 29 million boomers have retired in the last eight to 10 years. This should not have come as a surprise to anyone who can successfully count because age is chronological. The amazing thing about being 65, the year before that you were 64 and the year before that you were 63 and the year before that you were 62, you knew when junior was gonna retire the moment he was born, all you had to do was add 65 to that year. Did we prepare for this? Did this country do anything to try to prohibit this worker shortage?

And the answer is no. Did we do anything to encourage the size of families? No. Did we focus on trying to import in the immigrant that we needed as opposed to the immigrant that desperately wants to get across the border? No. Did we train? No. Did we do anything for this? No, we didn’t. And now we have wages that are hitting 6%, 7% growth, not yet actually keeping up with inflation, but it is certainly contributed to the inflation that we’re seeing now. And unlike supply chain and oil, both of those things will eventually correct. You will see the supply chain correct; people will take advantage of the opportunity to produce somewhere else. We’re seeing more reassuring all these things to counter the supply chain collapse. Oil prices will come down, they already have. We’ve seen them drop from that 120, 130 barrel range down into the eighties and nineties, these things correct? Wage inflation doesn’t. Once those wages go up, they stay up and it’s very difficult to reverse a wage driven inflation. Fourth factor is kind of related to that whole issue of wages, and that is the reassuring.

The good news is we’re bringing a lot of business back to the United States. Companies that are disillusioned with trying to make the global supply chain work are moving back to the U.S. I’ll talk more about this in a minute, but we’ve seen a trillion dollars worth of reassuring this year already, and we’ll probably see a trillion a year for the next several years. Very good news in terms of bringing jobs back, bringing production back. However, it also brings back higher prices because if you’re producing in the United States, you’re paying U.S. wages, you’re paying U.S. taxes, you’re paying U.S. regulatory costs. The reason people went overseas in the first place was to find lower production costs. When they bring it back to the US, higher production costs and that therefore means more inflation.

The fifth factor, which was a big one in 2021 and kind of faded through that year, was the money that was being pumped into the economy during the 2020 recession. We saw about 800 billion poured into the country trying to compensate for the shutdown. That certainly drove inflation in late 2020 and even into 2021 because there was a lot of money in circulation coming from the government. Did it really offset the 10 trillion that we lost in 2020? Not really. And it was fairly dissipated by the time you got to the middle of 21. But it was a factor, and that is still a little bit of a lingering concern because we still have, as we’ll talk about in a minute, a lot of money in the hands of the consumer even yet we don’t know what they’re gonna do with it, and that’s something that’s gonna determine what this year looks like even into next year.

So just quickly on the oil thing, we’re getting back to a balance between production and consumption. The crude forecast, maybe around 90 bucks a barrel. Gasoline, 3.50, 3.60; diesel may be around 4.00. All of those dropping from what they were in this last year. So various reasons to worry about the recession. GDP slow down was certainly one that caused some concern. The high rates of inflation that continue to drive central banks to high rates. When you listen to the conversation among central banks, they kind of put it bluntly to say, “Look, we raise rates in order to break the economy.” So we reach a point where the economy breaks, and generally that is around employment. Once there’s a break point, then we start lowering rates in order to fix what we broke. And that’s the pattern. We’ve seen it for 50, 60 years. If you follow the patterns over time, what generally happens is central banks push those rates up to the point that something breaks.

Arguably the U.S. may be right close to that now. Then they start to stop raising rights and then they start looking at when they lower them again, if the models hold, that means that rates would start coming back down again June, maybe May of next year. Now, does this work every time? Of course not. It’s an economic model. So our models remain somewhat flexible but that’s a pattern that we’ve seen repeatedly over the last seven or eight decades. The reasons to remain calm basically revolve around employment. Employment is still strong, but there are some things about it that are a little bit unusual. Many would assert that now would be a good time for companies to be doing layoffs and in previous recessions they would have by now. But what I’m hearing from almost every manufacturer, construction, you name the sector, they’re all very reluctant to lay people off.

They said, “Look, it took us years to find these people. It’s taken us years to train them. We’re not gonna go through this again. I’m not gonna lay these people off and then have to find them again 8, 9, 10 months from now. So I’m gonna do everything in my power to cut costs before I lay off anybody.” And this is a little unusual; many times in previous recessions, that was the first step. Lay people off, save some money and hire ’em back whenever you need ’em. Well now there’s not confidence that you can hire them back. We have a very high quit rate right now, highest that it’s been in 20 years, and the quit rate is a real sure sign of people’s confidence in their ability to get on their job because a quit is different than just taking a new job.

A quit means that you woke up this morning and you just said, “I’m done. I hate my job. I hate the people I work with. I hate my boss. I quit. I passed 15 ‘help wanted’ signs last week. I can find another job anytime I want.” That used to be almost entirely service sector jobs. People felt like they could go to work for another restaurant or a hotel or whatever, whatever. Now it’s being driven by it. People in the IT sector know they can get a job anytime they want as well, more so than probably any other profession. I mean it – people are probably thinking, “God, I could list on my resume that I’m a part-time serial killer and I would still get a job.” Therefore, there’s an awful lot of flexibility within that sector and we’ll talk more about that as we go through too. So the employment situation is still very solid, but it’s a little bit artificial in the sense that companies that would have laid people off aren’t at this stage.

So if you look at some of the indicators, they’re not bad. I mean, real business sales continue to climb and climb aggressively. We’ve been coming out of 2020 like a rocket. We grew by almost 6% in 21 and we continue to grow. All the others are still growing not as fast, but industrial production is up, the latest numbers are up. Point four, real income continues to hold. Steady came back up after 2020 and employment continues to rise. Remember last Friday, everyone was saying, “We’re gonna see a reduction. There’s not gonna be a lot of hiring.” Instead, we added 126,000 jobs, not the numbers we’ve seen in previous months, but a lot more than people expected to see.

We are going through the second of two weird years, 2020, 2021. Never gonna be able to compare them to much of anything because they’re very artificial. 2020 was a recession by edict, 2021 was a rebound from the pressure applied in 2020. By the time we get to this year, we’re kind of settling back into a more normal pattern. If you follow this assessment out, even as we’re declining, we’re only declining back to where we were 2015, 2016, 2018, which were considered normal years. So you’re seeing kind of a return to past patterns, which feels very slow compared to what we saw last year.

These next few slides are things that my company does. We started this about three years ago, four years ago, and it’s been remarkably accurate. The guy that helped us develop this as our partner in all this as a retired lieutenant colonel who used to be in the artillery, and he pointed out that as an artillery officer, accuracy was really, really, really important. And he developed a very complicated system to track where those shells were gonna go. So he has taken those same algorithms and applied them to the manufacturing industrial sector, which underlies the US economy.

As they pointed out, were still a highly manufacturing oriented economy. So three things to pull out of this graph. Number one, the blue line. That is spectacular growth. That was coming off of a long period of kind of stagnant growth, but because of the worker shortage and the inventory issue and the supply chain, you saw a lot of investment in domestic manufacturing, which is reflected in that blue line. But then you get to a point where you’ve done the inventory build, you’ve got the machines in place, you don’t really need to do any more of it, and you get a decline. But the decline halts in the middle of 2023 and reverses. And so by the time you get back to late ’23, early ’24, you’re back to the levels that you saw when you were growing so fast in ’21. The chart on the right is the latest version of this, which shows that that line is a little less steep.

You get a little earlier, recovery tends to be a little bit flatter, and then you see the growth. That little hook at the end is still there in both these graphs and that’s an indication of inventory. If the inventory is not consumed by them, then you’re going to have a little bit of a slowdown ’cause companies are not gonna need to build inventory. So that’s the hook that is waiting on consumer behavior. If the consumer is buying up the inventory, you don’t get the hook. But if they sit on their hands, which they might, then it stays. You look at specific industries and remarkable turnarounds. Aerospace was in decline in August; in September, it was roaring ahead and a lot of this is because the business traveler is back. The airlines are trying to keep up with the demand. Almost everything that’s driving that growth is parts.

Not actually new airplanes – though, those are coming online too. But the fact is the airlines are wearing out their equipment and they’re having to add parts and they’re doing it almost frantically trying to keep up with this demand. Automotive’s another one that’s been growing like crazy, and this is a result of the supply chain breakdown. The demand for automobiles was very strong. The suppliers couldn’t meet it. And now you’re in a situation where literally every vehicle that’s coming off the assembly line is pre-sold. We work with a company that advises car dealers. They’ve never seen anything like this. They’ve got 2-300 customers making payments on cars they don’t have and won’t have for another year or two. They will have paid for the car before they ever get it because they wanna be the one that gets the car and not be told to wait another two years while consumption and production match up.

So the automotive sector is on a tear. Machinery, not so much – big growth, a lot of growth as companies are adding in robots and machines. Then it ended and until that machinery wears out or there’s more demand, you have a decline. When you look at things like primary metals and fab metals, they’re the underlying drivers of the industrial community and they’re hugging those performances pretty closely. But look at the variance with primary metal. I mean that’s kind of what you see with hurricane forecast. And if this was a hurricane forecast, it would be saying, We think it’s gonna hit Florida, but it might hit Maine. So lot of variability. If we get a lot of demand coming in the next several months, you actually see growth in the primary metals. If you don’t see the demand, I mean it’s crushing decline and that’s gonna revolve around vehicles and construction, metal prices reflecting that same kind of performance.

Metal prices are generally down from the peaks that they hit not that long ago, but lots of variability. Steel consumption, pretty consistent, which is gonna tell you a lot about what’s happening on the construction side as well as vehicle production. Mention that one of the things we look at is industrial capacity utilization. Ideally you wanna be between 80 and 85%. If you’re under 80%, you’ve got slack, you’ve got machines that are not being used to their full capability, you’ve got less than productive workers. Between 80 and 85% is where the sweet spot is. Over 85%, now you’re running into bottlenecks. We have not been at 80% in almost 10 years, so suddenly we’ve been 80% for four months in a row, which would suggest that companies are kind of getting to where they need to be. They’re have built up their machine capability, their workers or productive, et cetera.

Durable goods order is also kind of hanging in there at levels we haven’t seen for a while. So hitting employment, just quickly, and I’ve been kind of beating this to death here for a while – the Fed has indicated that when unemployment hits 4.5% is when they will consider the economy has been broken, that you have now raised rates enough and harshly enough that it’s affecting employment. The latest employment numbers for 3.7. So we’re still a ways away from 4.5. The Fed therefore has more room to move should they want to. There are 10 million opportunities, 6 million people theoretically in a position to take them. But most of those 6 million lack the skills needed to take the 10 million jobs on offer. So this is one of the challenges is that we have people that are looking for work but they don’t have the skill levels. And that creates a real dilemma and goes back to my point earlier that we could have done a lot more with training at some point along the way, but we didn’t.

You can see where the jobs were being lost and where they were being gained. A lot of gains in warehousing and transportation and all these different things that kind of fed into the virtual shopping world declines in things like travel and accommodation and clothing stores. I mean, you really have to feel for people in the clothing business because two-thirds of the population hasn’t bought a pair of pants in two years. What’s changed? As well as people’s expectation of work, what they want out of a job. It used to be that having a lot of flexibility was not that important. Now it’s the number one concern. “I want complete job flexibility. I wanna work when I feel like working.” Some of that is a little self-indulgent, but there’s actually a reason for a lot of this – care responsibilities. The boomer is getting even with their children.

At one point when they were young parents, they at some point turned to the child and said, “Payback is gonna be very uncomfortable. I’m currently taking care of your every need, changing your diapers, dealing with all kinds of stuff. They’ll come a day young man where you will be changing my diapers.” And that’s what’s happening now you have an awful lot of people, Gen Xers and millennials that are taking care of elderly parents and elderly grandparents and having a flexible schedule is no longer a luxury. It’s like “My dad has Alzheimer’s, I’ve gotta be there for him. I gotta take mom to the doctor that can’t tell ’em to wait. So you now have a lot of people who are saying, I’m not doing this to be a pain. I just have to recognize the fact that I have dependents at home that I have to take care of.”

We have seen an improvement on transportation. This is an index that Armada has run for years and it shows basically capacity issues. And as recently as January, February of this year, we had 14 loads for every truck. Now we’re down to four. Still a capacity shortage, but not as bad as we’d had. Container rates have now come back to semi-normal. They’re still high as compared to what they were maybe three or four years ago, but at least they’re not at the atmospheric prices they were even earlier this year. Inflation is the hot topic. It has been. Presumably the politicians will talk about something else now because they don’t really have a lot of control over inflation and embarrass themselves by claiming that they do. But it’s also a fairly hard thing to measure.

What we will see frequently is the CPI, the new CPI numbers are out soon. I think some of them have already been released. CPI is current and helpful, but it is not the most accurate measure of inflation because it’s based on two assumptions. One is the assumption of the basket itself. The way this is figured is that a basket of goods is created, a mythical basket of goods. You add up all that an average family of four spends in a month and then you add it up again for the next month. And the difference is inflation. But that’s assuming that you got the basket right and it’s assuming that there’s such a thing as an average family of four. And the fact is that that basket changes drastically depending on age. Cohort boomers don’t spend like Gen Xers. Gen Xers don’t spend like millennials. Millennials don’t spend like Gen Z. So the basket varies. Furthermore, without that standard family, the family of four is the rarity now not the norm.

So what the Fed looks like, or looks at, is PCE; they pay very little attention to CPI. What they look at specifically at the very bottom of this chart is12 month PCE inflation Trimmed Mean. Trimmed mean – you remember your stats class and how much fun you had there – trimmed mean just means you’re taking the highest and the lowest out so that you get a better average. The Fed wants PCE to be around 2%. They would tolerate 2.5, but it’s currently sitting at about 4.5. So it’s roughly two points higher than the Fed would prefer. Still means inflation is high, still means the Fed is gonna be taking steps to deal with it. But when you start to see the overexcited headlines, “Oh my god, inflation is 8%, 9%,” whatever. Just take a deep breath and say, no, it’s not. It’s four and a half percent – still high. Not saying that it’s not an issue, but it is a little less intimidating than saying it’s as opposed to 10%, ’cause really it’s not.

Most of the consumer import as far as inflation has come from food and fuel. Those are the non-core, very volatile prices. They change drastically from one month, one week, one day to the next. We know why oil prices have been high. We know why food prices have been high. There’s not a lot of mystery to it. I mean they’re linked. Half the reason that food prices are high is the transportation costs have been so high and the transportation costs are high because fuel prices have been high. So it’s the entire system kind of revolving around the issue of fuel and the cost. Therefore, you take things for example that are a little unusual. The diesel prices have been very high in this country, higher than one would expect simply because we’re shipping as much as 30% of the diesel that we produce to Europe.

We’re trying to help the Europeans deal with their energy crisis by shipping them fuel. The good/bad news of this is that the bad news is we’re seeing higher fuel prices because of it. The good news is if we really did hit a crisis where we desperately needed that diesel fuel, well we could stop shipping it to Europe. This would not be good news for the Europeans, would probably change their attitude about the Ukraine war, which we don’t want them to do, but it is an option. It’s something that we could do if we needed to. Another chart that doesn’t really reflect a recessionary mood, capital spending is still way up. It’s still hitting records. Granted, cap spending always looks like an EKG. It goes up and down and up and down and it’s violent changes one direction or another. But the point is that companies are still doing a lot of investment and is being driven by the things I’ve been talking about for the last 35 minutes. Manufacturing automation and robotics construction, often to accommodate that automation and robotics and building inventory, wholesale trade, the movement towards machinery and automation is now even getting into the service sector. This has been very common in manufacturing, but now it’s hitting the service side as well.

For example, I encountered my first robot server at a conference hotel not a month ago. So I go downstairs for my breakfast and I order my breakfast and they give me this little device, which I assume is a pager and it’s gonna tell me to come pick up my food. Oh no, it’s connected to a robot. So as I’m sitting at my table, this little robot rolls up wearing an apron, it says Marge, and it comes up to my table and chirpily says, “Good morning, you ordered eggs benedict, a glass of orange juice and a cup of coffee. Would you please sample your coffee to see if it’s the right temperature?” So I do. “If you’re satisfied, please press my green button.” So I do and Marge whirls around and says, “Thank you. I’m leaving now.” Best service I’ve gotten in months. The little robot actually cared if my coffee was hot.

So I asked the guy at the restaurant, I said, “This can’t be cheap. I mean this is state of the art stuff here.” And he says, “No, it’s not cheap at all. But I am so tired of dealing with the people that I have to hire to be service or they don’t show up half the time if they do show up, they’re drunk or stoned or just have a bad attitude. I have two kinds of customers at this place. I’ve got business people who are here for conferences like you or I have the elderly population that’s come to play in the casino. Neither one of you guys wants to be dealing with somebody with a bad attitude wearing more metal on their face than I have in my kitchen. So I invested in Marge here and honestly it’s been a boom. The elderly will talk to her for 20 minutes. Doesn’t say much, but she’s a good listener.”

I mean it’s just, I’m astounded. I mean this place is just humming along with a robot server and it’s like, yep, the robot revolution is in full swing. And that’s a lot of what’s driving some of this capital spending. We’ve seen global manufacturing numbers declined, but not to the point of collapse. Even the US is still barely above that 50 line. We’re at 50.8, still expansion, not contraction. The power of the purchasing manager’s index is simply that. It’s honest. You get a lot of surveys, many of them are not trustworthy. My least favorite survey for example, is the consumer confident survey, which you hear discussed all the time. That’s derived from some random phone call to some random person asking them if they feel confident. What? The average person is like, “Sure, why not? I guess I don’t know.” You’re not really asking somebody who knows very much and can’t really answer the question that effectively.

You go to a purchasing manager and you say, “Are you buying more or less steel? More? How come?” “I don’t know. I don’t even know what we make. Somebody told me to buy more steel and we’re out of toilet paper. I’m the purchasing manager, man, I just buy what people tell me to buy. I don’t know why we buy it. You think I’m gonna question my CFO and say, ‘Sir, why are we buying this?’ He’s gonna look at me and say, Bentley, shut up and do your job.” So it’s accurate. It just is. They’re either buying more, buying less, buying the same, and if they’re buying more, it’s expansion. If they’re buying less, it’s contraction. So it’s a very quick shorthand and the PMI is done exactly the same for every country on this list. So you can effectively compare the US to Italy, to France, to the Netherlands, whoever you wanna compare to.

We’re seeing inventory to sales ratios basically tell the story of who is under stocked and who is overstocked. Still a tremendous under stock situation for automotive, retail and generally merchant wholesalers. The automotive sector has been hit by the supply chain. The retail sector has been hit by the delivery of the supply chain. Retailers now are getting in the stock they ordered for last spring. So they’re going into the Christmas season with a load of shorts, t-shirts and flip flops, wondering if they’re gonna get their coats in before winter leaves because the supply chain has been so disrupted and so much of their product is still in transit, still trying to get to the U.S. coast. That will eventually work itself out. Eventually you start to get the supply chain back under control either because those original suppliers catch up or you find replacements we find more reassuring, et cetera, in the U.S.

Construction is still showing good performance. There’s been a lot of conversation about the decline in demand for single family, which is real. Mortgage rates are high, prices are still high though coming down a little bit, but it’s priced the vast majority of homeowners out of the market. And also because so many people anticipated this last year, this year that if you were in the market for a home, you’ve already bought it, you wouldn’t be waiting at this stage, you were going to do that purchasing while the mortgage rates were still low. But what’s growing is multi-family. Multi-family has not seen this much permit activities since the 1980s. We are still short 5 million homes in the us. If single family isn’t an option, then multifamily is, and you’re seeing a lot more multifamily expansion tends to be very regional. That’s always the case with residential construction.

It kind of goes where the growth is, but we have not yet seen any sort of collapse on the multifamily side when it comes to non-residential construction. A lot of warehousing, a lot of logistics, a lot of transportation oriented activity. But even office buildings are making a little bit of a comeback. The bloom is off the Zoom row. We know the limitation of Zoom. It’s still a very useful tool, but a lot of companies are like, “Okay, we’re done with the all virtual workforce. We need to get back to the office. We need to have interaction, we need to have our sales people on the road.” So there’s not as much desire to push people into a permanent work from home environment. And that has allowed office buildings to start making a bit of a comeback. So again, looking at housing permits are forward looking.

Total permits down 14%, but the multifamily strongest since it’s been since the mid eighties, reassuring I’ve mentioned this two or three times and it’s basically bringing production back to the US because the advantages of being overseas have faded. 68% of supply chain managers rethinking the entire system. They’re gonna shift to other countries in Asia, they’re gonna look to other countries in the world, but they’re also gonna bring stuff back to the us. French shoring is now the big term. If you’re gonna do business overseas, do it in a country that doesn’t hate you. So our relationship with China is deteriorating by the day and that’s good news for Vietnam and Thailand and Korea and countries that have a closer relationship with the us but it also means a lot of movement back to the middle of the US particularly. And that’s being driven by transportation more than anything else.

Not to go into gory detail, but Kansas City Southern Railroad is the smallest of the class ones, but it has the best penetration into Mexico. So all of the manufacturing cities in Mexico are tied into the KCS system. They have been a target for every major railroad for decades, but the surface transportation board would not allow that merger because they did not want to see an anti-competitive arrangement. So Union Pacific and BNSF and CSX and Norfolk Southern, you name it, none of them were allowed to buy KCS. Along comes Canadian Pacific, which is the second smallest class one, they said, “We want to buy KCS.” And the Surface Transportation Board says “That’s okay if the two smallest railroads wanna combine, that makes them competitive with the big ones.” The point that affects reshoring is that in order for Canadian Pacific to pull this off, they had to have a plan and the plan was to divert as much as 45% of the freight that’s coming into the west coast to the middle of the United States.

They’re gonna bring it into Vancouver, which Canadian Pacific controls and Lazaro Cardenas & Mexico, which KCS controls, rail it to the middle of the country, literally up and down the I-35 corridor and do the break bulk logistics there. That is adding up to an estimate between 800,000 and 1.7 million containers additional per week hitting the middle of the U.S. So it’s a major change in terms of distribution and logistics and kind of anchors a lot of the reassuring in the middle of the country. Still have the biggest concerns, which is labor supply and we’ll see how that works out. The estimate is about a trillion dollars a year inuring per year for the next seven to 10 years. Everything from national security motivations to just simply production costs. A lot of manufacturing is triggering construction because as they add inventory and machines, they need more space. And we talked earlier about the impact of the dollar and how it affects our exports.

We’re not as export dependent as, say, the Germans. They rely on it for 55% of their GDP, but it’s 15 to 20% of ours. So it’s not insignificant. And as the dollar varies in value, so does our export activity. And so here is the kicker, and I’m gonna shut up now because there may be questions and I don’t wanna completely dominate the whole hour. This is the 3.5 trillion question. What does the consumer do with that money? There is still a lot of it out there and it is predominantly in the hands of those who make more money in that 50 to 100, 200K and up. Those who are less than 50K have reached their limit. They’re being hit hard by inflation. There’s not much discretionary spending taking place there, but the discretionary money is in the hands of those with money. Part of the reason they have all that money is that that level of income was a service oriented group.

85% of what they spent their money on prior to 2020 was services. Suddenly they were not given access to those services anymore. So they weren’t spending on it anymore. They saved it. We went from a 6% savings level to a 38% savings level in 2020. A lot of that money is still there. So what do we do with it? Are we gonna spend it this year in the holiday season? If so, we kind of spend our way out of a recession. If we hang onto it because we think that next year is gonna be worse, then we kind of urge a recession to take place. Still the jury is a little bit out. We have seen a pretty strong Halloween, but we are now into Black-Vember, which is what used to be Black Friday, and we’re gonna be watching what the consumer does with that money.

One thing I was looking to do earlier today and the data just isn’t out there yet, is the impact of the elections. And we don’t quite know yet what that’s gonna be. We don’t know who’s gonna control what house precisely. The important thing to note about the political situation and the economy is in almost everything the government does when it comes to the economy is long term. They can’t change what’s happening right now. I mean one of the parts that just drives me nuts is the mulling and carrying on about inflation. And I just wanna turn to these guys and say, “What do you plan to do about it? Got plan there do you? Got a instant thing there? Just you’re gonna come into office and that’s the end of that.” The inflation built over several years and if you’re going to reduce it, you’re gonna have to make some long term decisions.

I mean you could have made the decision to build up our workforce over the last 10 to 15 years, but you didn’t, could have done something to control the debt and deficit, but you didn’t. You could have developed some new programs that would stimulate the economy, we didn’t do that either. So what happens from here is they’re going to be a movement to start focusing on some of these long-term economic issues. I don’t see it at this stage from either party. Most of them have been fairly preoccupied with social issues rather than economic issues. Kind of understandable. Getting into the economy is tough and the decisions you make may not pay dividends for decades, but that’s kind of the situation we’re facing. Traditionally, when you have a government that is split where you have the executive in one set of hands and the legislature and another, it tends to be a little more balanced in the sense that government is not capable of doing big things and it kind of leaves it to the business community itself, the consumer itself, and these days more to the states because they’ve got more flexibility to move.

So at this stage, it’s likely that we have kind of a less engaged government in some respects, at least on economic issues. I think they will again put a lot of their emphasis into the social stuff, which is very important and matters tremendously. But as an economist, that’s not what I focus on. So with that, I’m gonna shut up and take questions and I couldn’t resist this. I give a talk not long ago to the associated women in the metals industry and every time I would talk about speaking to women in the metals industry, somebody would think that I was talking about metal music. So I saw this and couldn’t resist. When the death metal song you comes on and you don’t know the lyrics, you’re just gonna sound like one of my cats on the way to the vet which is generally even more violent than this. So with that, I’m gonna shut up and take questions. Don’t know if they’re gonna come in via chat or if Tom or Bridget will field them for me.

Tom Barrett:

Thank you, Dr. Kuehl, this is Tom Barrett. I will, we have one question right now. Why did the price of gas go up prior to the Ukraine/Russian war?

Dr. Kuehl:

Probably anticipatory because there was a great deal of discussion prior to the invasion that Russia was going to do something in the Ukraine. No one knew exactly what, There were a lot of threats that you could see that the military was massing and there were lots and lots of veiled diplomatic threats. The oil sector is always anticipatory. It is always trying to figure out what’s going to happen and the assumption was that Russia was gonna do something and the US and Europe was going to react in some way. And if it did, the only thing it could really do to affect Russia theoretically was to affect their energy and oil gas exports. And so the anticipation was that there was gonna be a shortage of fuel. The other thing that was driving those prices early was that we were getting to see the consumption come back that was a little earlier than people thought they would see.

Cause we had shut down a lot of our capacity in 2020, ’21 because the demand wasn’t there. But suddenly in ’21 here comes the demand again and you’re starting to see the oil sector ramping up with a certain amount of trepidation because they were like, “Well, we think it’s coming back,” but we still see a lot of people working from home and if they continue working from home, they’re not commuting. If they’re not commuting, they’re not consuming fuel. So when you watch the oil sector kind of understand that, they tend to look out routinely about four to six months. They’re kind of looking at a quarter or two ahead, trying to anticipate what demand and supply will look like. They frequently goof it up and don’t accurately predict either one, but that’s kind of where their mindset is.

Tom Barrett:

Well, thank you. I have another question here. When do you expect to see interest rates dropping in the consumer and housing market?

Dr Kuehl:

They will probably drop in conjunction with a change in Fed policy. So if we get that model that I mentioned earlier of hitting peak right about now, or maybe the next time they meet, and then 6, 7, 8 months later seeing the rates start to drop, we’re looking at May, June, July summer of next year – if the interest rates are even being talked down by then; even if the Fed is not actually reacting and lowering the rates, that will start having an impact on the consumer sector and it almost will be driven more by individual banks and lenders anticipating that these will go down and trying to get out to the market quickly. So there’s no guarantee, no requirement that a bank match up with the Fed rates. And so you’ll see some of the more aggressive banks saying, Hey, we’re gonna lower mortgage rates so we can catch some business. And those will tend to be smaller banks that basically are looking at their own community. So best guest estimate May, June, July of next year is when you would tend to see a lot of consumer rates begin to either stabilize or actually fall.

Tom Barrett:

Thank you! Dr. Kuehl, I don’t see any further questions and for the participants here you’ll see receive a survey at the end of this. We really appreciate your participation. Any closing comments, Dr. Kuehl?

Dr. Kuehl:

Nope, I think that’s about it. We’re kind of in that wait and see position that we are always in this time of year. We’re trying to see what the consumer actually does. We got a real good lesson in the effectiveness of polls over the last couple of days because everybody and their brother was saying, “Hey, it’s gonna be a massive red wave.” And then it turns out not to be, so predictions of what people will do is always risky and at the moment we’re thinking the consumer is thinking cautiously, but at the moment they’re not acting that cautiously. So we may end up seeing a more robust end of the year than we thought. So I tend to still be in the somewhat glass-full category. I don’t think we’re heading into a serious real recession. I think we’re having sector recessions. We’ll definitely see a downturn, but I’m feeling like it’s gonna be relatively short. So we’ll see how well I do – ask me six months from now. Thank you.

Tom Barrett:

Okay, thank you. We have another question just popped up. Do you see consumer goods dropping or will they stay the same as everyone is already paying the higher prices?

Dr. Kuehl:

Yeah, I think the consumer goods sector is one of the more volatile and it always reacts to the mood of the consumer. You have a lot of the retailers right now are kind of locked in a weird position. They are desperately discounting all the stuff that came in late that they wanted to sell in the spring and summer and couldn’t. But they’re driving prices up on the stuff that is supposed to be coming in now because they’re not getting it in the supply numbers they expected. So winter things are expensive, summer things are cheap. I think overall the consumer prices will probably ease, particularly as we get closer to Christmas ’cause they always do. They’re trying to unload inventory and then we’ll just watch to see whether there’s a reaction at the beginning of the year. My estimate is that consumers will not see the huge after-Christmas sales that they’re used to. Much of that will come really early, try and unload inventory they don’t want, and then it’s gonna be sitting tight for a while after the first of the year.

Tom Barrett:

Well, well thank you. Thank you very much. I see you’ve got two publications up on the screen. Could you tell us

Dr. Kuehl:

About them? I do, I can. The flagship is put out three times a week every Monday, Wednesday and Friday. We are just as long winded in print as we are in public. The subscription is seven bucks a month, same as a Starbucks caramel macchiato. Then that chart that I showed you with aerospace and automotive and primary metals, all that, that’s the strategic intelligence system and that comes out monthly. There’s a free two month trial to that. There’s a free month trial to the flagship. So all you need to do is send me an email if you would like to see either one of those or both. You can also visit our website, which I cleverly did not put on the screen, but it is www.armadaintel.com. So A-R-M-A-D-A-I-N-T-E-L and that’ll have all the information on how to get the free trials.

Tom Barrett:

Well, a lot of great information Dr. Kuehl. We really appreciate your time and we appreciate your presentation.

Dr. Kuehl:

Thank you. Very good. Thank you. Have a good afternoon.