Market Forces Shaping our World in 2015: Economic Trends

This is Part 1 of a five-part series on trends to consider as we enter 2015. Today, we focus on economic trends that will influence demand next year and beyond:

America is back. Falling oil prices, a strong U.S. dollar, falling unemployment and low inflation provide strong momentum going into 2015. The U.S. economy grew a seasonally adjusted 5% in the third quarter, its strongest showing in 11 years[i]. GNP growth is projected to be 3% in 2015. However, the CBOE Volatility index, (the bellwether for stock market volatility) is at its highest level of the year. The only constant in the stock market is chaos.

Kiplinger projects the following economic conditions for 2015:

Business Spending +7% in 2015
Housing Starts +15%
10 Year Treasury at 3.1% by the end of the year
Inflation less than 2%
Unemployment 5.3%
Federal Deficit 2.5% of GNP (down from 2.8% in 2014)
Retail Sales +5%

Hot topics for 2015 include:

The World of $60 Oil
On a global basis, the disequilibrium of energy may be the biggest variable. In a complex socio-political climate, low oil prices pit the Saudis and OPEC against regimes such as Iran and ISIS. Oil exports represent more than 80% of revenue for the Saudis, and the government needs a price of $83.60 to balance its budget, while Iran needs a per barrel price of $153. [ii]

The U.S was to become the largest producer of oil next year, and begin exporting energy for the first time since 1973 (before the shift in prices). The Saudis still control pricing with 266 million barrels in reserve.

The strength of the U.S. dollar supports lower oil prices. The Russian ruble is crumbling, putting Vladimir Putin’s under severe pressure and reducing his influence around the world.

The sudden price drop has a broad impact on American consumers. Compared to June prices, Americans save $630 Million per day in fuel costs and should prices hold, the projected windfall would be a staggering $230 Billion[iii]. At these levels, the global economy would grow an additional .5-1.0%.

Lower prices are a reversal of fortune for the burgeoning American energy sector and will have a regional impact in states such as the Dakota’s and Texas. The sudden shift in pricing could force some shale producers into bankruptcy in 2015. [iv] One thing that is unique about the oil business is that prices directly impact supply (as drillers stop drilling and refiners stop refining). Projects such as in the Alaska Sea and Keystone will simply be delayed until prices rise.

The World According to Janet (Yellen)
December 19^th was a momentous day in the history of the United States, as the Federal government sold its interest in Ally Financial Inc. the last significant asset in $426 Billion bailout of the U.S. Government[v]. Remarkably, the 2008 Troubled Asset Relief Fund that bailed out GM, Bank of America and Citigroup (amongst others) netted a small profit (pending the sale of some small banks and their mortgages).

As we have climbed out of the recession, our nation is at an economic crossroad, where economic growth will no longer be driven by artificial monetary policy. If there has been a lesson learned in observing the recent economic demise of Europe, it is that there is a balance between austerity measures and growth. Unlike the somewhat fractured European Union, the U.S. can employ a more balanced approach to fiscal and monetary policy.

Looking ahead to 2015, the Fed has made clear its intent to end quantitative easing, and to raise interest rates. The Federal Funds Rate has been zero since 2008. It is projected that the rate will be between 1.25-1.50 by the end of the 2015. Even at slightly higher rates, the markets for auto loans, mortgages and commercial lending are still favorable.

Regional banks that carry much higher reserves than they did before the Great Recession are still somewhat tight-fisted. Larger banks have swung back to easy money lending, and there is still the threat of an unexpected “market accident” that throws world markets into a tizzy. New rules for large banks will constrict lending in the long term. While some pundits point to bubbles in student loans or other markets, the weakness in Europe or a further slowdown in China are perhaps the most likely threats to the global economy.

Unemployment and Wage Stagnation
One of the more tenuous outcomes of the Great Recession was deepening wage inequality and the stagnation of the middle class. Fed Chairman Janet Yellen offers the following explanation of “pent up wage deflation”. In a downturn, employers are more apt to lay people off than to cut wages. In an ensuing upturn, wages do not catch up with demand. Thus, downturns and upturns create disequilibrium for wages.

Jobless growth is a global problem. In the U.S., it is estimated that unemployment would have to be below 5.2% for wages to rise through market forces alone. While there is movement toward an increase in the minimum wage, Congress will not raise the Federal minimum wage (the President’s executive order only affects government workers).

November marked the sharpest increase in factory payrolls this year. True movement in disposable income, coupled with lower energy prices could offer the American consumers a boost.

Factories, offices, and retailers hired more employees in November, just in time for the December shopping season. [vi]Employment is expected to expand by a healthy 3 Million jobs in 2015. [vii]

The World Economy is Flat
The Eurozone is expected to grow only 1.3% (compared to 3% for the U.S.) next year. [viii]European economies are experiencing disinflation (the condition when economies are experiencing neither inflation nor deflation).

There is conflict between the leaders of France, Italy, and Germany about the size of budget deficits and the appropriate level of stimulus. The European Central Bank is positioning to buy government bonds in order to save Europe from falling into a recession. [ix]

There is a pullback in oil-rich Canada, with growth projected at 2.6% as its currency is expected to slip relative to the U.S.. [x] The Bank of Canada has historically increased interest rates in lockstep with higher American rates. South America will also be relatively soft.

While the Chinese are pounding their chest, they face very significant economic problems, including factory overcapacity and office/retail rents in cities such as Beijing, exceeding those in New York and Chicago. Significant wage inflation will reduce China’s pricing advantage. Advances in automation and robotics further reduce China’s total cost advantage. Pollution is rampant, and the government is experiencing greater discontent on the part of its sizable population.

Potential bubbles in China’s debt and real estate could be the next global crisis.

China’s growth rate which has hovered around 10% is expected to drop to 7% or less, signaling to the world that it may not be the premier region for investment.

The Shifting Tide in Retail
Kiplinger’s projects a healthy 5% increase in retail sales in 2015. The consumer’s penchant for thrift continues, and some segments of retail are experiencing significant decline. The abrupt exit of Abercrombie and Fitch CEO Mike Jefferies in December (not even sex sells) only reinforces weakness in American malls where we are in a period of contraction. Aeropostale is closing 300 stores, and American Eagle Outfitters is struggling as teenagers are shifting their spending online.

Online catalog spending is increasing at an 11% clip during the holiday season while Black Friday and Cyber Monday performance was mixed.[xi] Discounters such as Walmart, Target and Kohl’s are trying to find their way in a multi-channel world, where consumers are “showrooming”, and have instant access to prices online.

Other significant economic trends:

The hottest sectors in 2014 were Utilities (+22%), Financial (+14%), technology +17% and consumer staples (+13%).
Businesses will be trending against a very poor Q1 in 2014 affected by unparalleled storm conditions and snowfall throughout the East Coast and Midwest.
S. merger activity will remain strong, and investment in America will be solid as investors do not have many other choices in a flat global economy.
Capital goods sectors such as biotechnology and aerospace remain strong.
Healthcare as a percentage of GDP has stabilized at 16% of GDP but is far higher than any other nation in the world.[xii] While Republicans will try (unsuccessfully) to repeal elements of the Affordable Care Act, the sector will remain strong through 2015. Nursing home and home health businesses will begin five years of growth as a result of an aging population.

Conclusions
The U.S. economy should be the strongest it has been in many years. In particular, the B2B climate will be fertile, with Kiplinger projecting 7% growth in business spending in 2015. Entrepreneurs should expect stronger forecasts from their sales teams (enough with the sandbagging). Expect a fast start relative to the poor 2014.

Assuming that current conditions hold, transportation and logistics companies (such as FedEx) should prosper (we don’t provide investment advice, so please hold your letters). Expect oil prices to normalize by spring. The valuation of the U.S. dollar will create a much bigger impact on importers and exporters than in recent years.

As in every year, particular sectors will outperform, but 2015 should be a time when America outpaces the world economy and is viewed as a safe harbor. As American payrolls swell by over 200,000 per month, wages should move higher, and it will get tougher to find experienced employees. Companies will invest in facilities, inventory, and equipment. [xiii]

Stay tuned for the other parts of our series this week.

It should be a great year.

[i] U.S. Economy Gains Momentum by Eric Morath – The Wall Street Journal

[ii] The Saudi Balancing Act by Arnsdorf, Carey and Dipaola– Bloomberg Business Week

[iii] As oil prices plunge, wide ranging effects for consumers and the global economy by Steven Mufson The Washington Post

[iv] Past and Future Tense – The Economist

[v] Bailout Approach A Final Reckoning, by Tracy Steinbert and Demos The Wall Street Journal

[vi] Hiring Surge Gives U.S. Expansion a Lift into 2015, Victoria Stilwell, Bloomberg

[vii] The Kiplinger Letter December 5, 2014

[viii] Bloomberg Business Week Special Issue: The Year Ahead in 2015

[ix] The Kiplinger Letter December 5, 2014

[x] The Kiplinger Letter November 26, 2014