Economic Growth – Energy Sector “Punches above its Weight”
In a webinar today that was chaired by S&P Ratings Services economist Satyam Panday, the agency’s market intelligence arm made some predictions based on their current economic models.
Panday said that growth is slowing in many of the world’s emerging economies and that sluggish demand has resulted in inadequate wage and employment growth. He said China represents risk because of its size. “China manifests its own economic challenges,” and that his group expects real growth in China to be 6.3% in 2016. That’s down from 7.3% growth two years ago. “A China slowdown would keep a lid on consumer prices globally.”
Panday said the group has revised growth expectations downward for the developed world, based on the downdraft from the numbers reported in the first two months of this year.
Here is the long and short of it:
- China: 6.3% growth in 2016
- U.S.: 2.3% growth in 2016
- Eurozone: 1.5% growth in 2016
- GDP: mid 2% or lower: “2.2% – 2.3% is what we are penciling in”
U.S. Outlook
Panday said the U.S. federal government is going to be a net positive contributor to growth, in spite of the Fed rate hike. He said they consider anything above 200,000 jobs added per month to be an excellent pace. Unemployment has come down below 5%; housing starts are starting to pick up, with multi-family rental units having rebounded to pre-recession levels. He said while U.S. growth is still slow, it is outpacing other more sluggish countries.
Talking about the Fed, Panday said “if our economic predictions hold, the Fed will make two moves – June and December. They’ll bring the federal funds rate up to 0.875%. If things slow down, they have no room: they are bounded by zero.” Although, he pointed out “in apparent defiance of the zero interest bound, central banks increasingly are imposing negative interest rates: Switzerland, Denmark, Sweden, the ECB. And now Japan has joined the club. Under this regime, financial institutions pay interest to the central bank on the liabilities the central bank issues to them.”
On his slide, Panday had an interesting thought on negative interest rates: “In principle there is no limit on how negative this interest rate could go, although at some point the implied tax would probably kill off the banking system!”
The Energy Sector – Oil Prices are a Double-Edged Sword
Panday said the energy sector is a small share of the economy, but it “punches above its weight.” “Oil prices are a double edged sword,” he said. “Still, we think lower oil prices are a net positive for the real economy.”
Panday showed a slide that looked at the effects of falling oil prices on the U.S. economy.
Positives
Trade Channel: “A back of the envelope calculation suggests that a $50 drop in the price of oil means U.S. spending on foreign oil would decline $240 million per day. That’s $87.6 billion per year – “money that becomes available for domestic consumption and therefore supports U.S. production and GDP in the short run.”
Consumer Channel: “with the typical American household buying more than 1,000 gallons of gasoline annually, this would be tantamount to a substantial tax cut for American households — $1 drop is $1,000 for savings, spending or paying off debt.”
Negatives
Domestic Energy Sector: “Employment and capital spending of this sector are already suffering, but this sector is relatively small as a share of the economy (although it punches above its weight) and the impact is more regional and quick.”
On their ‘Headwinds to Growth’ slide, the section under “industrial production limping and exports faltering” included investment slow-down in the energy sector (oil price related), and the retreating manufacturing sector (sluggish global economic environment and strong dollar, excessive system-wide inventories).
U.S. Credit Trends
The actual title of the presentation was “Credit Conversations: Credit Conditions in the Evolving Economic Environment.” S&P Ratings Services Managing Director David Tesher gave an overview of U.S. credit trends.
Tesher said he was watching the expansion of rated issuers into Single B credit. He said this was largely driven by energy and commodity companies on the investment grade side. “Oil and gas, metals and mining are our greatest negative bias.” Tesher said there has been a proliferation of Single B rated bonds and not so much for refinancing; he said his concern is that the Single B proliferation is for new financing. He said as we see more challenges in the high yield market, or if rates rise quicker than predicted, lenders will be able to dictate terms; and commodities, metals and mining may have trouble accessing capital.
Tesher showed a slide that compared Speculative Grade bonds in Dec. 2009 – 1,259 Rated Issuers to February 2016, which has 1,645 Rated Issuers. Of the 2009 SG Rated Issuers, 8% were positive, 58% were stable and 28% negative. In Feb. 2016, the 1,645 SG Rated Issuers, 4.3% were positive, 74.6% were stable, and 17.8% were negative.
Tesher put up a slide that showed U.S. ratings were “quite stable but commodity related sectors have the most negative bias.” Of the 18 sectors shown on the negative bias measure, the group at the top of the list for most negative bias – in order – were:
- Oil & Gas
- Mining and Minerals
- Energy Merchant Co.
- Regulated Transmission/Transport
Those were followed by the Restaurant and High Tech sectors. At the bottom was Real Estate with the smallest negative bias. As far as feeling the impact from China’s slowdown, the highest impact was on Metals and Mining, with the lowest on Oil & Gas.
Tesher summed up credit conditions as follows:
Conclusion: Challenges, Uncertainties and Risks
- Fed policy normalization process and unintended consequences including funding risk
- Growth challenges and geopolitical concerns overseas
- Organic revenue growth and profit margins under pressure, with diminishing returns coming from ongoing cost cutting programs
- Strong dollar hurting manufacturing and exports and creating competitive advantage for imports
- Shareholder-friendly activity remains robust
Tesher said that more profit has been generated by cost cutting than by organic revenue growth, and as M&A dries up, there will be diminishing returns from further cost cutting.
