by Louis Navellier

October 5, 2021

The most dramatic global economic story is that many economists now expect China to fall into recession for the first time in nearly 30 years as Evergrande Group continues to miss interest payments on its bonds.

The first thing any visitor to China notices is the vast array of empty buildings. The reason that there are an estimated 60 million vacant high-rise apartments in China is that many middle-class citizens view these apartments as their main “investment.” And now, the Communist Party leaders want Evergrande to finish all the massive real estate projects it has started, even though many contractors have not been paid.

Years of unrestrained real estate lending in China will likely ebb as Evergrande will need to sell many of its assets to restructure its debt. So far, the Evergrande crisis appears to be contained in China, despite the fact that Evergrande will miss more interest payments, denominated in both Chinese yuan and U.S. dollars.

Another sign of looming recession in China is that their National Bureau of Statistics reported Thursday that its purchasing managers index declined to 49.6 in September, down from 50.1 in August. Since any reading below 50 signals a contraction, this 49.6 reading tells us that China is slipping into a recession.

China is now experiencing increasing electricity outages in many provinces as it struggles with high coal prices, but many have fixed electricity rates, so many Chinese coal power plants are closing down for so- called “maintenance” issues, since they do not want to operate at a loss. As a result of high energy prices and fixed lower prices, electricity rationing is now common and that is apparently curtailing production.

I should also add that in some parts of China they are also striving to curb energy consumption to reduce carbon emissions to ameliorate their choking air pollution. So just like California, Britain and Germany, China is struggling to become increasingly “green” as hydroelectric output drops, and China does not have the ability of easily switching to natural gas in most provinces, due to a lack of infrastructure.

Fortunately, here in the U.S., we are in much better economic shape, which positions us as global leader.

The U.S. Economy is in Much Better Shape than China or Europe

Last week’s economic indicators were more upbeat than usual. For example, the Commerce Department announced that durable goods orders rose 1.8% in August to a record $263.5 billion, which was substantially better than the economists’ consensus expectation of a 0.6% rise. The transportation sector was up 5.5%, due largely to a 77.9% surge in commercial aircraft production, while auto production declined 3.1% due to the ongoing semiconductor chip shortage. Excluding transportation, goods orders rose 0.5%.

Also, new orders for non-defense capital goods surged 9% in August, which bodes well for continued strong orders in the upcoming months. Another example of the big order backlog is that so far this year, durable goods orders are up 24.7%, while shipments rose only 14.1%. There is no doubt that the shipping crisis and bottlenecks at the ports are contributing to this massive order backlog. Also notable was that July’s durable goods orders were revised up substantially, from a 0.1% decline to a 0.5% increase.

In other news, the Conference Board announced on Tuesday that its consumer confidence index declined to 109.3 in September, down from 115.2 in August. It is now at the lowest level in seven months. The present situation component declined to 143.4 in September (down from 148.9 in August), while the expectations component declined to 86.6 in September (down from 92.8 in August). Lynn Franco, the Senior Director of Economic Indicators at The Conference Board blamed it on Covid, saying, “Consumer confidence dropped in September as the spread of the Delta variant continued to dampen optimism.” By the same reasoning, if the Covid concerns were to recede, consumer confidence would rise once again.

The Labor Department on Thursday reported that new weekly unemployment claims rose to 362,000 in the latest week, up from 351,000 in the previous week. This was the third straight week that weekly jobless claims rose. These increases in new claims may persist since companies are now laying off unvaccinated workers due to the Biden Administration’s vaccination mandate for companies with 100+ employees, even though most of these unvaccinated workers may not be eligible for unemployment.

On Friday, the Commerce Department reported that consumer spending rose 0.8% in August, up sharply from a 0.1% contraction in July. Personal income rose 0.2% in August, so the savings rate declined a bit. Any time consumers spend more than their income is a sign that consumer sentiment remains positive, so despite the consumer sentiment decline in September, consumer spending remained healthy in August.

Also on Friday, the Institute of Supply Management (ISM) announced that its manufacturing index rose to 61.1 in September, up from 59.9 in August. The new orders component was unchanged at a healthy 66.7. The backlog of orders component rose to 64.8 in September, up from 61.4 in August. The supplier deliveries component rose to a whopping 73.4 in September from 69.5 in August, which indicates that some backlog orders are being fulfilled. In the end, supply chain issues and port bottlenecks continue to impede manufacturing output, but a rising order backlog bodes well for strong manufacturing activity.

In the meantime, inflation persists, which is great news for growth stocks, since they are a natural inflation hedge. Another good inflation hedge is residential real estate. For example, on Tuesday, S&P CoreLogic updated their 20-city Case-Shiller National Home Index, which rose 19.7% in the past 12 months through July. Home price appreciation only slowed in 3 of 20 major metropolitan areas, namely Cleveland, Detroit and Washington DC. Phoenix remained the urban area with the fastest appreciation for the 26th straight month, as their median home price soared 32.4% in the past 12 months. Housing inflation persists but it should cool off in 2022 as affordability issues should curtail prospective home buyers.

Speaking of inflation, the Fed’s favorite inflation indicator, the Personal Consumption Expenditures (PCE) index, rose 0.3% in August and has now risen 4.3% in the last 12 months, which is the highest level in 31 years. The core PCE, excluding food and energy, also rose 0.3% in August and is now running at a 3.6% pace in the last 12 months. Fed Chairman Jerome Powell told the House of Representatives last Thursday that the surge in prices this year “is a function of supply-side bottlenecks, over which we have no control.” However, Powell spooked the stock market when he added that the Fed faces a “Difficult trade-off” if inflation does not moderate, even though he expects that “inflation will come down.”

Adding up all the relevant indicators, the Atlanta Fed lowered its third-quarter GDP estimate to an annual pace of +2.3%, down from its previous estimate of 3.2%. Overall, the U.S. seems constrained by ongoing port bottlenecks, which are getting worse as retailers strive to stock up on merchandise for the holidays.

Europe Suffers From a “Bad Bet” on Green Energy

No matter how bad our supply shortages seem to be, they are much more acute in Europe. A big high-pressure system (and beautiful weather) neutered much of the wind turbines in Europe, which they now rely on for electricity, so natural gas prices have skyrocketed in Europe. Normally, countries in Europe would be stocking up on natural gas reserves in the fall as winter approaches, but high spot prices for natural gas have caused much of their natural gas reserves to be largely depleted. Russia supplies most of Europe with natural gas, so Russia is poised to profit from this crisis by stockpiling precious supplies.

Complicating matters further, in Britain there are now lines at petrol stations as many gasoline grades have been depleted, due to a shortage of truck drivers due in turn to a lack of foreign workers post-Brexit. Effective this week, Prime Minister Boris Johnson will be utilizing the British military to deliver fuel, for as long as the truck driver shortage persists. Due to a six-fold increase in natural gas prices in Britain, plus fuel shortages for vehicles, I do not recommend Prime Minister Boris Johnson call an election now, since British citizens have suffered enough, after Covid-19 created the worst recession there in 311 years!

Speaking of elections, the left-of-center Social Democrats in Germany defeated Chancellor Angela Merkel’s Christian Democratic party with 25.7% of the vote, while Merkel’s party received 24.1%. This was a big surprise. Even President Joe Biden said, “I’ll be darned,” so the U.S. relationship with Germany may become increasingly complicated as Germany shifts further to the left, which may undermine NATO and other defense alliances due to severe criticism from Social Democrats. It may take months for a ruling coalition to be formed by the Social Democrat’s Olaf Scholz, since German parties are very fragmented, and the powerful Green Party must be appeased with significant investments in clean energy.

It will be interesting to see where natural gas price end up if we have a cold winter in both Europe and the U.S. While Germany is embracing natural gas as a clean fuel in its green movement, the U.S. remains somewhat hostile to natural gas, viewing it as a “transition fuel” until the U.S. has no carbon emissions in 2050 and beyond. The problem, of course, is that it is hard to generate “green energy” in the dark winter months. The fact that Europe’s wind turbines froze last winter just exacerbates the green conundrum.

As Brent crude oil crosses over $80 per barrel and natural gas prices soar, it appears that a new “green energy crisis” is evolving, aided by governments that are overly hostile to fossil fuels.

All content above represents the opinion of Louis Navellier of Navellier & Associates, Inc.

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