Sixth Largest Trade Deficit in History Seen in May
The Dilemma Facing the Fed
By Chris Puplava, July 12, 2006
The trade deficit rose by 0.8% to $63.8 billion compared to the revised April deficit of $63.3 billion, though it came in below analyst expectations. Economists from Moody's Economy.com forecasted a deficit of $64.0 billion and Thomas Financial Consensus forecasted a deficit of $64.5 billion. May's deficit was the sixth largest deficit ever recorded, with oil imports and a widening trade deficit with China contributing to the imbalance.
The goods deficit with China rose 4% from April to May, increasing from $17.0 billion to $17.7 billion. The goods deficit with the European Union increased from $9.4 billion in April to $10.8 billion in May, while the goods deficit with Japan decreased from $7.8 billion in April to $7.1 billion in May. Relative to May of 2005, imports of goods and services rose 12.7%, whereas exports rose 12.6%.
The U.S. sent $27.9 billion dollars to foreign countries to pay for our oil demand in May, rising over 21% from May's oil bill of $23 billion. Both price and consumption led to the substantial increase in May's foreign oil bill, where the unit price of crude oil was $4.92 per barrel higher than in April and total crude oil imports increased from 293 million barrels in April to 323 million in May. The increase of $4.92 per barrel in May from April marked the biggest monthly jump in crude prices since a $6.06 increase from August to September 1990 after Iraq 's invasion of Kuwait sent global oil prices soaring. The January-May value of energy-related petroleum imports, not seasonally adjusted, is $116 billion this year compared to $86 billion in 2005, an increase of 35%.
Year-to-date, the trade deficit is running at an annual rate of $763 billion, 6.5% higher than last year's record of $716.7 billion. The large and persistent trade deficit continues to pose a concern as a share of GDP are unsustainable over the long run where trade deficits lead to higher external debts. This can raise our country's exposure to financial market disturbances and may increase the volatility of currency adjustments.
The sixth largest trade deficit on record for May as well as the Job's report released last week are posing more concerns for the economy. Looking deeper into the Job's report last week shows two key areas of weakness in the economy, the U.S. consumer and housing.
Table 1. June Employment Situation
Note: Numbers in thousands, seasonally adjusted
Source: Bureau of Labor Statistics
Housing Slow Down:
- Manufacturing (NET) ............ 15,000
- Furniture and Related Products.......... -1,100
- Construction ................................................. -4,000
- Logging ........................................................... -900
Consumer Led Slow Down in Economy:
- Retail trade (NET)............................................ -6,600
- General Merchandise Stores........................... -13,900
- Department Stores ......................................... -7,700
- Miscellaneous Store Retailers........................... -3,800
Retail trade employment was down 7,000 in June following the large decline in April of 33,000 jobs lost. The areas within retail seeing the largest declines in June were general merchandise stores, which lost 14,000 jobs in the month. General merchandise stores accounted for most of June's decline in retail trade employment followed by department stores and miscellaneous store retailers, which lost 7,700 jobs and 3,800 jobs in June respectively. Retail employment is now down by 86,000 jobs since March.
The Job's report for June showed continued weakness in housing as 4,000 jobs were lost in the construction industry and though manufacturing posted a 15,000 increase in jobs, the furniture and related products industry posted one of the greatest job losses for June, down 1,100 jobs. Within manufacturing, the wood products industry saw the largest decline, losing 2,600 jobs, which helps explain the 900 jobs lost by the logging industry, with both industries related to housing via construction or furnishing. The slow down in housing has sent the housing inventory to sales ratio soaring as seen by the figure below.
Source: Dismal Scientist
Economic data is clearly pointing to a slowdown in the economy lead principally by housing and now potentially via a slowdown in consumer spending as evidenced by weakening retail employment. The likelihood of a mid-cycle slowdown or possible recession in the future is increasing amid a consistent interest rate raising cycle and inflation and high energy price persistency. With this economic backdrop the markets have historically gone defensive which is currently the case over the past few months as seen by the outperformance of the consumer staples and healthcare sectors relative to the S&P 500.
Figure 3. S&P 500 Consumer Staples Relative Performance
Figure 4. S&P 500 Healthcare Relative Performance
Defensive industries have done well during periods of economic weakness as seen by the historical returns over two different mid-cycle slowdowns provided in the table below by BCA Research.
Note: Industry returns reflect relative performance versus the S&P 500
Source: BCA Research
After periods of extreme price movements, prices tend to revert back to their mean. A review of the sector breakdown of relative performance to the S&P 500 is given below to measure whether a sector is overvalued or undervalued relative to its historical mean over the past 16 years, a method used by Standard & Poors. Values over 100 indicate outperformance relative to the S&P 500 (120 = 20% excess return) and values under 100 indicate underperformance relative to the S&P 500 (80 = -20% return) and a value of 100 indicates equal performance. The red lines indicate two standard deviations above and below the mean, with values falling within the two redlines approximately 95% of the time. Values near or beyond the red lines indicate statistical extremes of value, either undervalued (lower red line) or overvalued (upper red line), where values should fall outside these limits only 5% of the time.
As seen in Table 2 above, in both the 1980s and 1990s mid-cycle slowdown, many consumer staples and healthcare industries and some interest rate-sensitive industries initially lagged the broad S&P 500 prior to the slowdown, though they outperformed afterwards. This can be seen in Figures 5 and 6 below.
Figure 5 shows the underperformance of the healthcare sector prior to the 1995 mid-cycle slowdown, where the sector saw extreme underperformance of the broad market in 1992-1993, followed by a sharp rebound and a period of continued outperformance until early 1999. Figure 6 shows the consumer staples sector underperforming prior to the 1995 mid-cycle slowdown as well followed by a shorter period of outperformance that ended in early 1997. In early 2000, both sectors showed extreme underperformance to the S&P 500, as both were at or even below two standard deviations to their respective means. As the market began to corrective and investors turned defensive, both sectors saw soaring outperformance that lasted until 2003, signaling the end of the bear market and the return of the bulls.
Both sectors have been performing in-line with the broad market or minor underperformance for the past few years. This may be coming to an end as Figures 3 and 4 above show both sectors outperforming the S&P 500 in the recent months. Further support for healthcare outperformance is the increase seen in drug demand where pharmacy and drug store sales have been increasing as well as pharmaceutical shipments. Additionally, consumer spending on prescription drugs is rebounding (see figure below).
Source: BCA Research
Figures 8 and 9 show the financial and utility sectors, both interest rate-sensitive. Both sectors put in bottoms prior to the 1990s mid-cycle slow down and the latest recession of 2001 followed by a period of sharp improvement in 2000, with both sectors rebounding from one extreme to the other, moving from their lower standard deviation band to their upper, roughly within the course of one year. Both sectors are currently performing in-line with their respective historical means and the broad market, though the utility sector has shown a weakening trend in its relative performance since late 2005. Neither sector is currently at a point of under or over value in terms of relative performance.
Figures 10 and 11 show slight outperformance for both the materials and industrials sectors, both hovering around their historical averages and showing an increasing trend in relative performance.
Figures 12 and 13 show the relative performance of the IT and consumer discretionary sectors. Both sectors are currently underperforming the S&P 500 and are slightly below their means, though not at point of extreme undervalue in terms of relative performance. The consumer discretionary sector's relative performance in Figure 13 shows an interesting trend. The sector displayed a multi-year weakening trend in relative performance prior to the 1990 mid-cycle slow down as well as prior to the 2001 recession which is the same pattern seen since late 2001 to early 2002. This potentially warns of another coming mid-cycle slowdown or recession.
The bear market in energy in the 1990s is clearly seen when looking at the sectors relative performance in Figure 14. The tides turned in 2000 when the sector saw strong outperformance, with excess returns relative to the S&P 500 of roughly 30% seen in early 2001. Since late 2003 the sector has witnessed continued outperformance relative to the S&P 500, though a weakening trend in outperformance is seen since mid 2005, with the sector performing just slightly above the market and above its historical average. The sector in terms of relative performance is not undervalued, nor is it overvalued.
Of the sectors shown above, consumer staples and the healthcare sector have the potential to outperform the broad market if we are indeed entering a mid-cycle slow down or possible recession, and would benefit from sector rotation. The energy sector may continue its period of outperformance as it is considered a late-stage cyclical sector within the business cycle.
In economic news, the Energy Information Administration (EIA) released its weekly petroleum report for the week of 07/07/2006. Crude oil inventories fell a sharp 6.0 million barrels to 335.3 million, with gasoline inventories drawn down 0.4 million barrels to 212.7 million. Both crude oil and gasoline stocks fell greater than expectations, with crude oil expected to fall 1.2 million barrels last week and a draw down in gasoline stocks of 0.1 million barrels was expected. Demand is picking up as seen by a 1.7% year-on-year (YOY) increase last week versus a 1.4% YOY increase seen in the week prior. In addition to the rising demand, a dip in refinery production was seen with refineries operating at 90.5% of capacity versus 93.1% in the prior week, currently below average for this time of the year as the hurricane season is set to pick up. Increasing demand coupled with falling petroleum stocks will continue to put pressure on energy prices and further increase our foreign oil bill.
The markets were down today after digesting the drawdown in oil inventories that raised fears of higher energy prices and pass through inflation and the news of the trade deficit, which was the sixth largest ever. The markets were in a clear downtrend until finally bottoming in the last hour or so of trading. Advancing issues represented 30% and 24% for the NYSE and NASDAQ respectively, with up volume representing 21% and 79% of total volume on the NYSE and NASDAQ.
All of the broad market indices were down, with the DJIA posting a triple digit loss, down 121.59 points to close at 11,013.18. The S&P 500 posted a double digit loss, down 13.92 points to close at 1258.60, and the NASDAQ was also down, falling 38.62 points to close at 2090.24. The 10-year Treasury note yield was flat, remaining at 5.1%, while the dollar index posted a gain on the day, rising 0.54 points to close at 85.90
Overseas markets were mixed for the day. Japan's Nikkei stock average fell 1.45%. London's FTSE 100 rose 0.06%, Germany's DAX index rose 0.39%, France's CAC-40 rose 0.56%, and Mexico's Bolsa and Brazil's Bovespa Index were both down, falling 0.77% and 0.89% respectively.
By sector, all ten S&P 500 sectors fell on the day with the greatest losses coming from the technology and consumer discretionary sectors, posting 2.19% and 1.64% loses respectively. The mildest declines came from the energy and telecommunication services sectors, down 0.17% and 0.63% respectively.
Spot gold prices rose $10.20 an ounce to close at $651.65 an ounce, West Texas Intermediate Crude (WTIC) oil rose $0.97 a barrel to close at $75.13 a barrel, and Henry Hub spot natural gas prices rose $0.09 per mBTU to close at $5.71per mBTU.
Have a pleasant weekend,
© 2006 Chris Puplava