What was shaping up to be a difficult week turned out to be somewhat different. As of September 1st, the U.S. and China began imposing new tariffs on each other’s goods and the U.S. reported its manufacturing sector contracted in August. However, as the week continued there grew a quiet optimism first with trade talks set to resume between the United States and China and then with predictions for another Federal Reserve (Fed) interest rate cut in September. The political winds seem to change direction often and in seemingly random ways. This week they appear to have moved in our favor.
According to the Federal Reserve’s Beige Book, the economy plugged along at a “modest” pace through the end of August. This language matches with the pace described in the July report. However, manufacturing activity was down slightly from the previous report and agricultural conditions remained weak. If a silver lining was to be found, it is in the fact that the majority of businesses remain optimistic about the near-term outlook. The key takeaway from the report was “modest” in almost every way.
Several Federal Reserve governors went on record this week. The consensus is that the economy is in a good place, but not without risk and uncertainty. New York Fed President, John Williams, points to the recent downward revision for GDP growth and sizable downward revision to payroll employment for 2018. One implication of these revisions is that the economy’s underlying momentum was already somewhat less robust than previously thought. Based on his, and others recent commentary, the market is now looking for one rate cut in September (in less than two weeks) and another in late October.
In company news, we have a few bits of information to pass along. On the back of a wildly successful opening in Shanghai last week, Costco has already made plans to open its second store in China. Considering the demand, this appears to be a significant growth driver for the company. Walmart announced it will discontinue the sale of some rifle and all handgun ammunition when its current inventory runs out. This is a big stand by the largest retailer in the United States and could mark a turning point. Amazon is pushing the boundaries of technology with the advent of a hand scanner. The company is testing scanners that can identify individual human hands as a way to ring up store purchases. And not to be left out, Kellogg unveils a new plant-based product line. My first reaction was, “but isn’t cereal already plant based?” Then I remembered the company also owns MorningStar Farms which sells processed meat in various forms.
One last thing before we get to the story of the week. A consequence of this historically low interest rate environment is that companies have been issuing debt in record numbers in lieu of raising capital by selling additional shares. Increasing the number of shares dilutes existing shareholders and generally brings on the ire of investors. However, generating additional debt for non-productive uses, i.e. buying back shares, is also viewed with a heap of side-eye. This week we learned Apple is issuing $4-5 billion in bonds, and while no one will question its ability to pay back this debt, most companies don’t have that kind of free cash flow or cash on the books. Issuing debt for non-productive uses has long been debated but more recently has become de rigueur in C-suites across the country. It is hard to make a blanket statement on the practice; however, it is worth questioning when taking on debt crosses the threshold from a corporate strategy to reckless behavior. Is corporate debt the next big bubble? Perhaps not today when rates are pushing the zero-bound, but this won’t always be the case.
To close out this week, I have to admit I got a bit of a chuckle out of this next story. I don’t think anyone enjoys paying income tax. However, as more jobs are being replaced with automation, it seems the IRS fears fewer will be paying an income tax. Oh, the irony. However, it’s a brave new world and the IRS is now considering taxing robots. With fewer workers, it stands to reason that there would be less income tax going into the government coffers. If a robot replaces a factory worker who produces say, $50,000 of work annually, the IRS is considering the idea that the company should be taxed at the same level to offset losses in income and Social Security. Perhaps the day will come when we don’t view automation as a threat, but will instead stand with our robot brethren against the tyranny (said tongue in cheek). I just wanted to bring this current situation to your attention. Now you know.
Bruce Mason, MBA