NORTH AMERICA OUTLOOK

By Dr. Chris Kuehl

What Recession?

It would seem to be such a simple request. “Mr. Economic Forecaster: Are we or are we not in a recession? How bad might this be, and when might we expect to be out of it – if indeed we are in one?” Too bad we in the soothsaying business seem incapable of answering this. A survey commissioned by the World Economic Forum resulted in 45% of those economists queried asserting that recession had already started and would be long and severe. Another 45% said that there would not be an actual recession at all – more of a mild slowdown. Apparently, the remaining 10% didn’t understand the question. In truth, there is data to support an optimistic view and data to support a pessimistic one. Lately, there have been some significant attitude shifts among previously downbeat economists, and they are starting to assert that the proverbial soft landing is not only possible but likely.

It all seems to depend on what sector of the manufacturing world a company is engaged in. When examining the Armada Strategic Intelligence System (ASIS*) there are sectors that are clearly doing better than others, although all of them have shown some signs of distress over the last several months. Automotive and aerospace lead the pack, but there has also been growth in the electrical sector and computers. The challenges are most obvious in machinery, primary metals, fabricated metals, as well as the oil and gas sector (although that has started to perk up). The good news is that the most recent data is pointing in a positive direction as there has been some decline in the pace of inflation at the same time that job growth has remained robust and consumers are still spending. Most important of all is the pace of capital spending. It is still at over $74 billion, and that is a record level. Much of this expansion has been down to integrating technology and automation. The fastest sector for construction these days has been manufacturing, as it has been up by over 76% in the last year. This has been almost all down to the use of robotics and the accommodation needed.

Capacity utilization is a key indicator for manufacturing. Generally speaking, the ideal reading is between 80% and 85%, as that indicates there is little slack in the system, but there is also not enough pressure to cause shortages and bottlenecks. The national readings have been in the high 70s. There is more slack reported by the respondents, but these numbers are higher than they have been in previous surveys. The good news is that most are reporting increased capacity, or they have been stable. Overall surveys show 32.58% saw increasing capacity and 50.56% are stable. Only 16.85% reported decreasing capacity. This is consistent with other manufacturing observations as companies shift more and more towards automation and robotics to cope with chronic labor shortages.

Another key indicator is new order activity. It shows growth more accurately than normal order activity as it signals new consumption levels.

The new order numbers from the Purchasing Managers’ Index carry more weight than the other indices. The new order data is somewhat encouraging as 31.28% report expanding new order activity, 39.11% report stable activity, and 29.61% indicate that new order activity is decreasing. The U.S. has recently slipped into contraction territory as far as the PMI is concerned –down to 46.4. This is not yet crisis territory but is getting worrisome. When these numbers are under 45, there is genuine concern regarding a slowdown. It was only a few months ago that the U.S. numbers were in the 50s. Canada is likewise in contraction territory with a reading of 48.8, but Mexico is still clinging to expansion territory with a 50.9 mark.

One of the key factors as far as the economy is concerned is employment, as it has been baffling. The anti-inflation efforts should have caused more of an impact on joblessness, but there have been relatively few layoffs.

Overall, respondents report that 24.44% are increasing their employment numbers and 60.56% report that employment has been stable. Only 15.0% report a declining workforce, and much of this appears to be attrition as opposed to laying people off. To be frank, the majority of manufacturers are reluctant to let people go as it has become so hard to find the skilled worker that nobody wants to lose the ones they have. The labor shortage has been chronic for years, and the most common pattern has been for companies to poach employees from their competitors and even their customers. The fact that wage inflation is faster than overall inflation indicates that unemployment numbers are very unlikely to worsen anytime soon.

There have been some bright spots as far as inflation is concerned. We have been watching oil prices stabilize in the 70s as far as per barrel prices are concerned, and that has meant declines in the price of diesel and gasoline as well as feedstocks for plastics. The challenge in the oil sector is not in crude output but in refining capacity, and where there have been price hikes for feedstock, it has been a refinery or transportation issue. There have been similar declines in steel and aluminum, although this reduction has been more recent. Roughly 32.96% of respondents have seen increasing prices, but 38.55% have seen them stabilize, and 28.49% have seen these costs decrease slightly. One of the more important cost shifts has come in the logistics sector. Just a quarter or two ago, most respondents reported that logistics costs were increasing quickly. The latest report showed that 49.16% saw these costs going up, and 44.69% saw them stabilizing. Only 6.15% saw these prices start to come down. This should change as the year progresses as the capacity issue has faded in the transportation sector.

At the start of 2022, there were 14 loads for every truck, and there were similar issues in rail and maritime. Now there are less than four loads per truck, and many of the new entrants into the trucking business are leaving. In 2022 and

2023, there have been over 65,000 new trucking operations (most of them single truck companies). Many of these new drivers came from the manufacturing community, and as they leave transportation, they will migrate back into their previous jobs in manufacturing and construction.

Yet another solid indication of a recession is declining capital spending and investment, but that rate is still very high overall. This is not pointing at a recession. Over $75 billion in Capex in the last year, and that is an amount that exceeds anything seen in three decades. Among manufacturers in general, 47.22% indicate their Capex investments are on track, 12.22% are delaying by only one quarter, 13.22% are delaying by two quarters. That still leaves 27.22% delaying indefinitely, and this is a concern long term.

In the final analysis, the real issue is confidence in the future. At this juncture, the attitude towards the future is generally positive. Fully 51.23% assert their business outlook is positive, while 31.48% report stability in that outlook. Only 17.28% report a negative outlook. This confidence level exceeds that of the consumer, but generally speaking, a boost in business confidence is reflected in consumer attitude about a quarter later.

What to make of all this? The bottom line is that the US has not yet hit stall speed. The recession that was predicted to start at the end of last year has yet to manifest. The growth in Q1 was above 2.0%, and it appears that Q2 was close to 2.3%. This is about the twenty-year average for the US economy. There are still plenty of warning signs and more pressure will be applied by the Fed, but thus far, the likely pattern for the year is a slowdown but with some sensitive sectors facing recession. The U.S. almost never sees a 100% recession or a 100% boom, there are always sectors that do well even as others falter, and likewise, sectors that struggle when everybody else is growing. The strong sectors now include automotive, aerospace, technology, electrical equipment, and health care (just recently). The sectors still reeling include traditional retail, office development, single-family housing, and business aimed at the lower third of income earners. The entertainment and travel sectors are starting to surge, and there has been more growth noted in the oil and gas sector. The plastic sector plays in all of these, and that creates the need for diversity.

Canada

This has been consistent for North America as a whole. Canada has been seeing substantial differences between provinces, and that has combined to take some of the growth out of the national economy.

Ontario has been hit hard by shifts in the residential housing sector, and the RBC now thinks that the 3.2% pace of growth set last year will fall to 1.1%. This is no recession by any stretch, but it is far less robust than had been expected. The light at the end of the tunnel is that housing numbers started a little rebound in the last few weeks. Quebec has been hit even harder when it comes to the residential sector and has also seen declines in manufacturing. The growth expectation is just 0.6%. There is a marked contrast with the central provinces.

Alberta is on fire economically with the success of the oil sector – growth of 2.4% and the fastest in Canada. Saskatchewan is not far behind in the strength of the agricultural sector – growth of 2.0%. This is, however, down from the blistering pace set in 2022. That was the year the farm sector led the way toward 5.7% growth.

Manitoba is also slowing from the 3.6% pace of last year to around 1.5%. This is due to some issues with the manufacturing sector and a reduction in export volume to the US.

British Columbia is taking some significant hits in a variety of sectors and will be struggling to hit 0.6% growth. Residential housing is down, along with overall consumer sentiment. The financial sector has been affected as well. Exports are down as BC has been caught up in some of the growing tension between the U.S. and China.

The Maritime provinces (Nova Scotia, New Brunswick, PEI, Labrador, Newfoundland) are all continuing to see slow growth and remain in the economic slow lane although Nova Scotia has been seeing a great deal of incoming migration from the U.S. that has boosted tourism and residential housing.

Mexico

The Mexican economy has been on something of a roller coaster the last few years (and, of course, they have not been alone). In 2020 the economy fell by 8.0% - one of the steepest declines of any nation in the western hemisphere. Tourism collapsed, and that had been the number three driver for the economy.

Manufacturing stuttered as well, and even remittances fell as migration into the US declined.

In 2021 there was a bounce back of 4.7%, but that only brought the economy back halfway. In 2022 the growth receded even more – to 3.1%, and the expectation for 2023 is between 2.0% and 2.5%.

For the last twenty years, the economy has underperformed, according to data from the World Bank. It has been averaging less than 2.0% growth, and the reasons have been persistent and varied. The issues include limited access to finance, bad infrastructure, regulatory burdens, and lack of security. The leftist government of Andres Manuel Lopez Obrador has stymied foreign investment and has prohibited much progress in terms of working with the U.S. on issues such as illegal immigration, drug smuggling, and the like. The relationship was obviously miserable while Trump was in office but was expected to improve under Biden. It hasn’t.

* The ASIS Report can be found at https://asisintelligence.com/.

Author profile: Dr. Christopher Kuehl (Ph.D.) is a Managing Director of Armada Corporate Intelligence and one of the co-founders of the company in 1999. He has been Armada’s economic analyst and has worked with a wide variety of private clients and professional associations in the last ten years. He is the Chief Economist for the National Association for Credit Management and is on the Board of Advisors for their global division – Finance, Credit and International Business. n