Construction Caught in the Cross Currents Fiscal Policy Helping Construction Cut Through Interest Rate Headwinds

The construction sector seems to be defying restrictive monetary policy. Total construction spending ended April up 10% on a year-over-year basis. To be sure, the recent rise in financing costs and tighter lending standards have weighed on project outlays, in particular residential and commercial development. A downdraft in new project starts for these types of construction suggests a drop in activity is ahead in the near-term.

That noted, several segments of construction have performed considerably better, thanks in large part to fiscal policy. Notably, there has been a boom in manufacturing project spending directed toward the build-out of electric vehicle and semiconductor supply chains following the passage of the CHIPS and Science Act. The Inflation Reduction Act and Bipartisan Infrastructure Law have been a boon for investment in energy and infrastructure projects.

Looking ahead, the fiscal tailwinds look set to only intensify over the next few years as more funding from these federal programs is distributed. Meanwhile, the drags imposed by restrictive monetary policy should begin to fade as the Federal Reserve gradually lowers the federal funds target rate. (…)

The rise in residential structures investment largely has been driven by new single-family construction. The rebound in single-family development over the past year reflects home builders’ ability to offset increased borrowing costs with mortgage rate buydowns and other pricing incentives to support sales. Low supply in the resale market and a growing “build-to-rent” market have been other factors which have given home builders greater confidence in the ability to sell the homes that are produced.

Looking ahead, home builders’ ability to use incentives, low supply in the existing market and sturdy economic growth are factors which should support a steady pace of single-family construction over the next few years. Growth should remain fairly limited, however, considering new home inventory levels remain elevated and the prospect of a “higher-for-longer” rate environment continues to weigh on home builder confidence. The NAHB Housing Market Index (HMI), which is a measure of builder sentiment, has shown signs of improvement this year but is still hovering at a depressed level well below historical averages. The low reading suggests that mortgage rates, which remain around 7% as of this writing, are still restraining buyer activity and looming over the future plans of home builders. Against this backdrop, single-family permits have weakened over the past several months, which suggests that builders are beginning to reassess production plans in light of this year’s spurt higher in interest rates.

That noted, we still believe that the Fed will initiate a rate cutting cycle later this year, which should enliven single-family activity. A structural shortfall of housing, both from sluggish new construction over the past two decades and the mortgage rate lock-in effect, should also continue as tailwinds for the new home market, where supply is relatively more abundant. All told, easier monetary policy should help single family construction maintain a positive trajectory.

Similarly, lower rates will likely help lift home improvement spending out of its current lull. Renovation and remodel spending shot up after the pandemic and subsequent home buying frenzy, but the rise in interest rates has since moderated the pace of spending. Given how levels of homeowner equity remain highly elevated as a result of the rapid run-up in home values in recent years, lower interest rates should bring about a faster pace of home improvement spending in the years ahead.

Multifamily construction is another category that will be helped by less restrictive monetary policy. Since the start of the 2022, multifamily development has contracted sharply. As shown in the below chart, the three-month moving average pace of multifamily starts fell to the slowest rate since the spring of 2020 during April. The recent pull-back is partially explained by tighter credit conditions for developers. Not only has credit become more expensive, it has also become more difficult to access as lenders have taken a more selective approach to lending amid increased market uncertainty.

Deteriorating apartment market fundamentals are another reason multifamily development is shifting into a lower gear. The apartment vacancy rate rose to 7.8% in Q1-2024, the highest since 2009 in the wake of the Global Financial Crisis. The increase has occurred largely as a result of new supply far outpacing demand. During Q1, there were nearly 153K multifamily units completed, a lofty level on par with the record high set in late 2023.

A potential supply overhang in some markets remains a concern, but adverse affordability and availability in the single family market will likely continue to bolster rental demand. Apartment net absorption picked up notably in the first three months of 2024, and absorption is tracking to be even stronger in Q2. Still, demand is likely to fall short of new supply in the medium-term, and tight monetary policy remains a significant constraint. As such, multifamily construction will likely weaken further this year. Longer-term, better balance in the apartment market, lower financing costs and easier credit conditions should eventually help bring a turnaround in construction.

  

(…) commercial starts for industrial, retail and office projects have declined considerably since the second half of 2022, most recently falling to the lowest levels since 2012. The fall in starts indicates that commercial development activity is set to remain weak in the near-term. Higher interest rates have not only made financing commercial projects more expensive but also slowed demand for the goods and services which ultimately drive real estate needs. For example, industrial and retail construction has cooled alongside a slower pace of consumer spending and moderating demand for warehouses and brick-and-mortar retail establishments. In addition to making commercial projects more viable from a financial standpoint, lower borrowing costs should help the economy maintain a sturdy pace of growth, and by extension, buoy demand for the more cyclically sensitive segments of commercial real estate.

Of course, factors besides interest rates are behind the drop in commercial development, especially when it comes to office construction. New office starts slipped to just 4.6 million square feet in Q1-2024, the lowest on records dating back to 2000. Even though newly built “trophy” office space has been relatively resilient to the negative effects of hybrid work, the office market remains awash with available space, which has pressured vacancy rates upward and applied downward pressure on rents. The rash of supply and highly uncertain prospects for future office demand in wake of hybrid work means new office construction should remain depressed for the foreseeable future.

On the other hand, the downward pressure on office demand from rising remote work prevalence is a reminder that digital transformation is underway and likely still in the early stages. To accommodate surging new investment in Artificial Intelligence (AI), cloud services and other digitalization services, there has been a marked rise in data center construction over the past few years. The influx of capital into expanding digital capacity from a wide array of investors and industries only appears to be accelerating, and demand for data centers is widely expected to fall short of supply for the foreseeable future. As such, data center development seems likely to remain a source of growth over the next several years.

  

Similarly, the need to fortify and expand the nation’s digital infrastructure appears to be one of the drivers behind the profound rise in manufacturing project spending. Since the final quarter of 2019, real spending on manufacturing structures has expanded by over 106% through Q1-2024. As displayed in the charts below, growth in most other segments of real private nonresidential structures investment has been tepid since 2020 with most categories still at or below the levels registered before the pandemic. Healthcare and education investment has improved recently alongside the need to update and improve existing buildings with new technologies, boost energy efficiency and accommodate demographic shifts. Despite the recent up-shift in these categories, manufacturing continues as a major driver of total structures investment.

The robust gain in factory construction appears largely as the result of new investment directed toward boosting domestic electric vehicle and semiconductor production. Although some moderation has occurred recently, the pace of activity should remain strong given the support from federal industrial policy. In 2022, the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act included $53 billion in subsidies for semiconductor production in the United States. A significant increase in private sector investment looks to be following the statute. Firms spanning the entire semiconductor value chain have announced nearly $450 billion in private investments since the passage of CHIPS, including over 80 new projects across 25 states, according to the Semiconductor Industry Association.

Infrastructure construction is another segment that appears poised to benefit from increased federal spending. While it has been roughly 2.5 years since the passage of the Bipartisan Infrastructure Law (BIL), the $550 billion in new federal spending originated by the bill has yet to fully roll out. As displayed in the chart below, the Congressional Budget Office recently projected BIL spending rates to pick up significantly over the next several years. The BIL provide funds for roads, bridges, mass transit, water and other infrastructure construction. What’s more is the Inflation Reduction Act (IRA) directing nearly $400 billion in federal funding toward clean energy projects such as electricity, transmission and transportation. The funding is delivered through tax incentives, grants and loan guarantees.

All together, the CHIPS Act, BIL and IRA stand to directly and indirectly boost a wide array of construction segments across the nation for the next decade. As shown in the map below, publicly announced state allocations for projects range from $1.6 billion in Delaware to over $45 billion in California. Using Arizona as an example, approximately $7.9 billion in BIL funding has been announced to date, including $4.7 billion for transportation projects, $1.6 billion for high-speed internet and $585 million for clean water projects. Similar to many other states, Arizona has also been a beneficiary of CHIPS and IRA, with $6.6 billion and $830 million, respectively, in public funding announced for a variety of manufacturing and clean energy projects. The state has also received approximately $115 billion in private commitments alongside the increase in public funding.

  

The construction sector appears to be navigating restrictive monetary policy relatively well. Despite higher interest rates, total construction spending has risen solidly over the past year, in both nominal and real terms. More recently, a decline in multifamily and commercial starts suggests the elevated rate environment is starting to significantly constrain activity. A thinning project pipeline of these types of projects suggests a weaker trend in overall nonresidential spending, which is likely to set in over the next few years. Elsewhere, fiscal policy appears to be boosting several segments of construction, namely manufacturing, clean energy and infrastructure projects. Looking ahead, the fiscal tailwinds are set to only intensify over the next few years as more funding from these federal programs is delivered. Meanwhile, the segments of construction most impacted by higher interest rates should start to improve as the Federal Reserve eventually reduces the federal funds target rate.

As a result, construction employment and high construction wages, normally highly interest rate sensitive, have yet to show any softness:

Rent Hikes Loom, Posing Threat to Inflation Fight Rising rents complicate the inflation picture and could make it challenging for the Fed to ease interest rates.

(…) While asking rents for new leases nationally are running nearly flat over the past 12 months, those figures are heavily influenced by the Sunbelt, where record-high supply has turned rent growth negative in some cities, according to most property data and brokerage companies that track them.

The least affordable home-sales market in decades is compelling more renters to stay put. Large apartment owners say fewer renters are moving out to buy homes than ever before, put off by record home prices, limited inventory and higher mortgage rates.

“Rental demand is definitely rebounding,” said Igor Popov, chief economist at the listings website Apartment List. “We’re past the bottom.”

Strong job growth has also opened the door for landlords to raise rents. “That gives them pricing power,” said Linda Tsai, a real-estate equities analyst at Jefferies. (…)

Shelter inflation, mostly a measure of rents that lags behind real market conditions by many months, was still running hot in May, with an annual rate of 5.4%, according to the Bureau of Labor Statistics.

“The housing situation is a complicated one,” Fed Chairman Jerome Powell said at a Wednesday press conference. “The best thing we can do for the housing market is to bring inflation down so that we can bring rates down.”

While most analysts say the pace of shelter inflation should decline further this year, some apartment landlords are signaling that the worst of the rent slowdown is already behind them.

“We believe we have likely already seen the maximum impact to new lease pricing,” said Tim Argo, an executive at the publicly traded building owner Mid-America Apartment Communities, on a May earnings call.

The Sunbelt landlord has been cutting prices for new leases. But the company said apartment absorption in the first quarter was at its highest for that quarter in two decades. (…)

In recent months, apartment buildings aren’t losing as many residents as they once were, market reports show, and available units are leasing fast. (…)

Big landlords are increasing rents on renewed leases by about 4% or more, according to their recent earnings statements. That is in line with recent historical averages and higher than general inflation. (…)

Despite the bounce off the bottom, most analysts don’t think big rent increases will return nationally this year. Commercial-property brokerage Newmark forecasts asking rents for new leases to rise 2% nationwide in 2024, well below the double-digit rates of the pandemic years. (…)

Chair Powell on his June 12 presser acknowledged that they misread the rent market:

(…) when market base rents go up sharply, as they did at the beginning of the of when the economy reopened, they really went up sharply. Those play into rollover rents much more slowly for existing tenants than they do for new tenants. And so, we’ve so we’ve found now that there are big lags. So, there’s sort of a bulge of high past increases in market rents. It has to get worked off and that may take, you know, several years.

“Market rents” (rents on new leases) overall never really declined as many pundits thought (many using narrower databases). Zillow’s data showed a bizarre sudden flattening in new rents this time last year but only for 3 months. Recent data show a more credible slowdown from +0.4% monthly between October 2023 and March 2024 to +0.26 in April and +0.20% in May.

On a YoY basis, Zillow rent growth rate has flattened to the 3.5% range. The BLS measure, still at +5.3% YoY is slowly catching up…

… but remains 10% below market. That “has to get worked off and that may take, you know, several years”.

• With the PPI and import price data in hand for May, the inflation modelers who map the CPI/PPI into the PCE now expect the core PCE index rose around 0.08%-0.13% in May That would translate to a 2.6% year-on-year core PCE inflation rate, down from 2.8% in April (@NickTimiraos)

U.S.: Core services inflation remains above 5% for 24th consecutive month

Global financial markets cheered last week’s weaker-than-expected US CPI data for May, with both the headline (+0.0%) and core (+0.2%) measures coming in a tick below consensus expectations. As today’s Hot Chart shows, the real question going forward is whether the ongoing deflation in core goods will be enough to offset the persistent inflationary pressures in core services, where 12-month inflation has been above 5% for 24 consecutive months – the longest such streak since the early 1990s.

Note that there is no precedent in modern US history for core services inflation to be above 5% while core goods are deflating. As US tariffs on Chinese goods ramp up, the possibility of disinflation stalling in the coming months remains. Keep in mind that the average base effect on core CPI from now to December will be only +0.17%, which means that, for the 12- month core rate to continue to fall, monthly results from now to the end of the year will have to be consistently below this figure. It’s possible, but it’s a tall order.

China’s property measures give sales a boost, but only in big cities

China’s latest property support measures have boosted transactions in its biggest cities, but activity in smaller localities is struggling to get off the ground, pointing to more pain ahead for most of the country’s real estate market.

On May 17, China cut minimum mortgage rates and downpayments and instructed municipalities to buy unsold apartments to turn them into social housing, sparking dozens of announcements from cities easing policies under the new guidelines.

Small samples of transactions data and interviews with 10 real estate agents across China show the measures had an uneven impact throughout the country, reviving demand in mega-cities such as Beijing and Shanghai, but not in smaller places.

This adds to concerns fuelled by poor home prices data on Monday that the downturn may have further to run, especially in the smaller cities where the quantum of excess supply is far greater than in larger cities, keeping pressure on policymakers to extend more support. (…)

Data from real estate research firm China Index Academy showed the average daily transactions for second-hand homes between May 18 and June 5 was 27.7% higher than the April average in Shanghai and 8.10% higher in Beijing. Transactions for new homes were down 0.2% and 6.4% respectively, with agents saying older apartments in Beijing and Shanghai typically sell faster because they are in better areas.

In Shanghai, one agent said inquiries for apartments have tripled since the city relaxed downpayment requirements on May 27, and noted 700-900 sales a day versus 500 previously. Another agent said home viewings increased 60%.

One agent in Beijing said viewings in the capital also increased “a lot.”

“Basically all agents are booked up,” said the agent in the capital, who only gave his surname Chen.

China Index Academy did not publish data for smaller cities, but separately released transactions data for the June 8-10 period showing a decline of 16% year-on-year for a group of 30 cities, including the largest ones.

This suggests sales in smaller cities are still weak and buyers are still wary cash-strapped developers may not be able to complete the projects.

“Smaller cities are doing a lot to incentivise people to buy more homes and it’s simply not working,” said Christopher Beddor, deputy China research director at Gavekal Dragonomics.

“Something is broken. I think that something is the developers: you can’t have a property market turnaround without persuading homebuyers that they will receive presold units from developers.” (…)

Smaller cities have lowered mortgage rates and minimum downpayments more than the bigger ones, but even the most aggressive cities have so far struggled to revive demand, agents said. (…)

It will be a slow grind but it has to start somewhere, somehow. These data on big cities are the first signs of a bottoming out process.

FYI:

• U.S. households currently own the largest share of the US equity market. Foreign investors are second. Both fickle… (GS via Isabel.net)

• FOMO Driving the Market

It is obvious that enthusiasm for all things related to artificial intelligence (AI) is the key factor in the market’s recent advance.  The move is driven by momentum investors pushing names like Nvidia (NVDA) and Broadcom (AVGO) ever higher.  That in turn leads to FOMO (fear of missing out) among institutional and individual investors alike.  Remember, FOMO is a very important factor among institutional investors.  No portfolio manager wants to substantially underperform their benchmark or peers, and since the performance is increasingly being driven by a relatively small cadre of mega cap tech stocks, they have no choice but to join the fray. (Steve Sosnick, Chief Strategist Interactive Brokers)

CONSUMER WATCH

Tuesday, we get May’s retail sales report. During the pandemic, spending on goods outpaced labor income and total spending. Retail sales grew in line with income and total spending in 2022. Since 2023, retail sales growth has been trailing and been more volatile. During the first 4 months of this year, retail sales rose 2.3% YoY on average. considerably slower than the 5.4% growth in payrolls.

The good news is that payrolls were up 0.57% MoM in May and 5.4% YoY. Also consider that CPI-Core Goods was –1.7% YoY in May while total CPI was +3.3%.

Analyzing its internal May data, Bank of America sees that consumer spending momentum slowed from last year but remains solid. “Total card spending per household grew 0.7% year-over-year (YoY) in May, following the 1.0% YoY increase in April.”

The Market Is Blowing Off What the Fed Is Saying About Rates

The Wall Street axiom warns to “never fight the Fed.” But that’s exactly what traders are doing, and it could spark a rally in some of the forgotten corners of the stock market.

Federal Reserve forecasts and comments from central bankers couldn’t be more clear. Investors are being warned that interest rates will stay higher for longer than they’d expected, with the median projection from Fed officials calling for one interest rate cut this year.

And yet cash is pouring into stocks that benefit from lower borrowing costs. The technology sector had $2.1 billion of inflows this week, the most since March, according to data compiled by EPFR Global and Bank of America. (…)

Historically, rate cuts have marked a key inflection point that has ushered in strong equity returns — but only for cycles that aren’t triggered by a recession, like this one. That would explain why the latest flows data from Bank of America and EPFR Global show a rotation into financials, materials and utilities — three crucial groups closely tied to the economy that historically benefit from rate cuts as long as there’s robust economic growth.

The consensus expectation is that economic growth will remain sturdy, with the Atlanta Fed’s GDPNow model projecting second-quarter real GDP growth climbing to a 3.1% annual rate, from a 1.3% pace in the first quarter. (…)

Aggregate equity positioning has now climbed to its highest level since November 2021, when the Nasdaq 100 was at a peak, data through the week ended June 14 compiled by Deutsche Bank AG show. (…)

Goldman Sachs Boosts S&P 500 Target on Upbeat Profit Outlook Firm lifts index’s year-end estimate to 5,600 by 2024’s close

The bank’s equity strategists led by David Kostin now see the US stock benchmark index finishing the year at 5,600, up from a 5,200 level they predicted in February. The new target implies a roughly 3% advance in the gauge from its Friday close.

Goldman’s upgraded target ties with that from UBS Group AG’s Jonathan Golub and BMO Capital Markets’ Brian Belski for the highest on Wall Street.

The upgrade in the target is “driven by milder-than-average negative earnings revisions and a higher fair value P/E multiple,” Kostin, the firm’s chief US equity strategist, wrote in a note to clients on Friday.

The upgrade comes one month after Kostin reiterated the firm’s 5,200 target, stating there was no further room for upside in the 500-member gauge through December. (…)

While the firm’s strategists maintained their earnings-per-share forecast for 2024 and 2025, they noted that robust earnings growth by the top five megacap technology stocks have offset the “typical pattern of negative revisions to consensus EPS estimates.” Kostin also raised the S&P 500’s price-earnings multiple he deems fair to 20.4 from 19.5.

Kostin gamed out several other scenarios in which stocks can run even higher than his new baseline forecast. If gains broaden out and lift the S&P 500 Equal Weight Index, the main, cap-weighted benchmark could rise another 9% to 5,900 before 2024 closes out. In his most optimistic case, if mega-cap “exceptionalism” persists, the gauge could soar to 6,300 by the end of the year.

Conversely, if earnings estimates prove too optimistic or recession fears resurface among investors, the S&P 500 could see a correction of about 13% and fall to 4,700.

More from Kostin:

• Five stocks have accounted for 60% of the aggregate S&P 500 index’s year to date return. MSFT, NVDA, GOOGL, AMZN, and META have collectively surged by 45% and now comprise 25% of the S&P 500 equity cap. The drivers of the rally include upward revisions to consensus 2024 earnings estimates for these same tech companies, and valuation expansion stemming from increased investor enthusiasm about artificial intelligence (AI).
  
• The five companies listed above posted 1Q year/year EPS growth of 84% vs 5% for the typical S&P 500 stock. Strong results for the past four quarters have prompted analysts to raise their 2024 EPS forecasts by 38% for these five Tech stocks. In contrast, the profit forecast for the other 495 stocks in the index have been reduced by 5%. Consensus 2024 forecasts imply a 31 pp gap between EPS growth for these five stocks and the median S&P 500 firm (37% vs. 6%). However, the gap is expected to narrow to 8 pp in 2025 and 4 pp in 2026.
• Aggregate S&P 500 EPS estimates are unchanged YTD. Stable S&P 500 earnings estimates are unusual. Historically, starting at June of the previous year, consensus estimates have been cut by an average of 7%. We expect revisions to consensus S&P 500 EPS estimates will continue to be milder-than-average through year-end given the upward revisions to mega-cap tech earnings that have already taken place this year. However, we maintain our earnings forecasts for 2024 ($241, +8%) and 2025 ($256, +6%), as we believe consensus margin estimates for next year remain too optimistic.
• We generate our aggregate S&P 500 P/E forecast by separately modeling the P/E for the equal-weight S&P 500 index and the premium of the aggregate S&P 500. We model the equal-weight P/E as a function of real yields, the distance of forward inflation from 2%, the tightness of the labor market, demographics, and the change in earnings growth. We model the premium as a function of the difference in aggregate vs. median long-term EPS growth and return on equity, as well as CEO confidence.
• Today’s aggregate S&P 500 P/E of 21.1x reflects an equal-weight multiple of 16x and a 30% premium between the aggregate and equal-weight index. Currently, our model implies a fair-value equal-weight P/E of 15x, 9% below today’s valuation, and implies a 40% premium of the aggregate vs. the equal-weight P/E, above the actual premium of 30%. Taken together, these two components imply a fair-value aggregate S&P 500 P/E of 20.5x, suggesting the index trades close to fair value.

Trailing EPS are now $226.51. Full year 2024: $244.73e. Forward EPS: $253.42e.

The Rule of 20 Fair Value P/E is 16.6 (20.0 minus inflation of 3.4%), very close to Kostin’s “16x equal-weight multiple”. The S&P 500 Fair Value per the Rule of 20 is 3760. The current 44% “overvaluation”, which takes no account of the “magnificent stocks”, is in line with Kostin’s calculation of a 40% premium accounting for the “magnificent stocks”.

Follow the leader:

Evercore ISI Sees S&P 500 Gain Raging On, Upping Target to 6,000 Emanuel’s previous target was among the lowest on Wall Street

Julian Emanuel, the firm’s chief equity and quantitative strategist, raised his year-end forecast on the S&P 500 Index to 6,000, the highest among major equity strategists tracked by Bloomberg — and roughly 10% above the gauge’s closing level on Friday. That’s an about face from one of Wall Street’s most prominent bears who previously expected the gauge to finish the year at 4,750.

(…) Emanuel says ebbing inflation and artificial-intelligence fervor will propel stocks even higher. (…)

Emanuel also raised his estimate for the index’s per-share earnings in 2024 and 2025 to $238 and $251, respectively. The new levels imply a 8% and 5% profit growth, he said. (…)

While AI exuberance has pushed valuations “to the top decile since 1960,” the S&P 500’s price-earnings multiples may remain elevated for “extended periods,” Emanuel said. (…)

Among the big Wall Street banks, JPMorgan Chase & Co. has the lowest year-end target for the S&P 500 at 4,200, implying a drop of more than 20% from Friday’s closing level.

Momentum Meltup, Blowoff Top, Or Both? (Ed Yardeni)

(…) Is this the start of an earnings-led meltup, a P/E-led meltup, or a classic technical blowoff top? Last week, Adobe, Broadcom, and Adobe all soared. Nvidia rose to yet another record high. Industry analysts are raising their earnings expectations for the S&P 500 Tech sector, which is now trading at 30.4 times forward earnings. That’s high, but still below the blowoff multiple of 55.5 on March, 27, 2000, just before the Tech Wreck. (…)

From Callum Thomas:

The *index* is the epitome of a bull market uptrend. Yet, over half of the 500 companies that make up the index are tracking *below* their 100-day moving averages. It’s a case study in narrow leadership and bearish breadth divergence.

Source: MarketCharts extensive indicator set and charting tools

Tech stocks are likewise going from strength to strength on the surface, but meanwhile the breadth of tech sector components shows a picture of relative weakness under the surface, even in tech. Or to put it differently, this is increasingly a market driven higher only by the largest of the largest in Tech.

Source:  @_rob_anderson

Another sign of narrow leadership is the extent to which individual stocks in the S&P 500 are underperforming vs the index (~2 thirds to May) — this is reaching similar levels as the later more-frenzied stages of the dot com bubble in 1998/99. It makes it harder for stock pickers to beat the index (other than just buying and market timing in the biggest stocks), but it also shows a vulnerability as any weakness in the biggest stocks could unwind all their hard work in dragging the index higher.

Source:  @FrancoisTrahan

TOO MUCH POWER!

China’s dominance of world’s supply chains is being tested

(…) At home, prices have collapsed after a breakneck expansion created far too much capacity, forcing many firms to sell at a loss. Abroad, China’s dominance of the world’s supply chains is being tested by an explosion in protectionism. And the rapid uptake of solar power, the best story going in the fight against climate change, is now facing resistance as electricity grids chafe at handling a flood of energy available in the day that then disappears at night.

“We’re entering into a deep down-cycle,” Amy Song, vice president at solar material maker GCL Technology Holdings Ltd., said in an interview on Friday with Bloomberg TV. “Barely anyone is making money right now.” (…)

The world added 445 gigawatts of solar panels last year, more than all other power sources combined in any year of human history. Most of them were made in China.

That’s propelled the growth of multi-billion dollar companies, which are now comparable to the giants of oil and gas. But it’s also created the conditions that have bedeviled commodities markets through the ages. China’s solar companies have boomed, and now they’re heading for a bust that could eclipse earlier downturns in the industry’s fortunes.

A surge in demand that began three years ago boosted prices, unlocking ambitious expansion plans that have resulted in too much supply. Chinese companies ended 2023 with the ability to produce 1,154 gigawatts of solar modules — more than double the capacity at the close of 2021. Projected demand this year is just 585 gigawatts, according to BloombergNEF. (…)

Companies looked out for their own interests without considering the overall impact if all their rivals acted the same way, said Gao Jifan, chairman of Trina Solar Co, the world’s third-largest manufacturer of panels. They were helped along by local governments eager to meet their growth targets and banks hungry to make loans, he said.

Gao was one of several executives who called last week on the central government to intervene to help the industry get back on its feet. The menu of options presented included regulating which new factories can be built, cracking down on less-efficient facilities, capping price cuts, and promoting consolidation. (…)

Industry executives have warned that bankruptcies are in the offing. (…)

Chinese companies control more than 80% of capacity along every step of the supply chain. (…)

Despite the dire outlook, there are reasons for optimism in the industry. Demand will continue to grow through the next decade, doing more than any other source to help the world decarbonize. And healthy profits from 2021 to 2023 mean many firms are sitting on large cash deposits to help them through the downturn.

But the issues faced by the industry are technical as well as commercial.

China installed a record 217 gigawatts of panels last year — more than has ever been built in the US — and solar now accounts for 22% of the country’s total generating capacity. But sunlight’s intermittency is straining the electricity grid.

Hundreds of small cities have halted approvals for new rooftop solar projects, and panels across the country are seeing their hours of usage reduced as the grid rejects their electricity because there’s not enough space for it during daylight hours. (…)

The broader solution is for grids around the world to build more power lines that can transfer excess clean power to where it’s needed. More storage, mainly via batteries, is also required. But adding those costs means solar power will need to keep getting cheaper.

For now, the industry is focused on belt-tightening. Longi Green Energy Technology Co., once the world’s most valuable solar manufacturer, announced earlier this year it would lay off thousands of workers. Others have halted production. Smaller producers are being forced to delist their shares from stock exchanges.

Wuxi Suntech Power Co. Chairman Wu Fei likened China’s solar sector to the home appliance makers of 15 years ago, when 300 or so companies vied to sell washing machines, fridges and air conditioners across the country. That industry has consolidated to just a handful of players, he said, and solar will likely follow suit. (…)

Meanwhile, in the USA (Axios):

A Maryland county just north of Washington, D.C., is embarking on an ambitious effort to provide clean, sustainable public transit — even to the point of installing a microgrid for its own electricity and hydrogen fuel production.

Self-sufficient energy systems, or microgrids, are emerging as an important clean energy tool for communities, businesses and government agencies.

• Microgrids operate independently of the main grid, like a sustainable island, ensuring uninterrupted power — meaning officials don’t have to worry about increased electricity demand.
• That’s crucial if you’re trying to run a fleet of electric or hydrogen-powered buses.

The 5.5 megawatt bus depot project, designed and operated by microgrid company AlphaStruxure, includes solar panels, electric bus chargers, battery energy storage and a hydrogen electrolyzer.

• The solar panels and Schneider Electric-built battery will supply energy to the electric bus chargers and power the electrolyzer, which splits water into hydrogen and oxygen molecules through a process called electrolysis.

• That locally-produced hydrogen will be used by the new fleet of fuel-cell buses.

Solar panels will power a hydrogen electrolyzer for clean transit buses in Montgomery County, Md. Computer rendering: Courtesy of AlphaStruxure

China Property Drag Is Getting Worse, Factory Output Disappoints Retail spending picked up but remains weak by past standards

Retail sales rose 3.7% from a year earlier in May, better than a 2.3% year-over-year increase in April.

Industrial production rose 5.6% from a year earlier, the National Bureau of Statistics said, slowing from April and missing the median forecast in a Bloomberg survey. Retail sales offered some encouragement, picking up more than expected, but Chinese shoppers remain far from recovering their pre-pandemic mojo.

Source: Bloomberg Economics based on National Bureau of Statistics

Overall fixed-asset investment rose 4% in January-May, down from 4.2% in the first four months — even though there’s been a pickup in government bond issuance to fund infrastructure spending. (…)

The acceleration in retail sales was the first since November. At 3.7% the pace remains less than half of the 8% or so that was typical before the pandemic, even though social and economic life has largely returned to normal. (…)

Seeking to shore up demand at home, China rolled out a program in April that offers incentives for businesses and households to upgrade old machinery. Part of the plan involves government subsidies for buyers of new cars. Monday’s data suggests the impact has been limited. Retail sales of automobiles fell 4.4% from a year earlier in May, only a slight improvement from the previous month.

In a survey of more than 400 top executives conducted by UBS Group AG over roughly a month through mid-May, firms reported weaker prospects for orders, revenue and margins compared with the same period of 2023. There was a drop in the share of respondents who plan to increase capital expenditure in the second half of this year.

(ING)

A tip for you! “Donald Trump’s proposal to exempt tips from taxation may add up to $250 billion to the federal deficit over 10 years, a budget watchdog group forecast.”

• Corporate Tax Rate Spurs Political Fight With Over $1 Trillion at Stake The two parties are trying to turn the 21% rate in opposite directions—with each percentage point worth more than $130 billion over a decade in tax revenue.

The rate could climb as high as 28% if Democrats sweep November’s elections and move as low as 15% if Republicans gain full power.

Top CEOs Are Flocking to Trump Again in Bid to Shape Agenda Seeing the chance of a victory by the former president, business leaders want a seat at the table.

(…) Many who distanced themselves from Trump following the Jan. 6, 2021, riot at the Capitol by the former president’s supporters have softened their criticisms. (…)

Dimon, Moynihan, Citi CEO Jane Fraser and Wells Fargo’s Charlie Scharf were all in attendance at the Business Roundtable meeting Thursday where Trump addressed the group. Trump told them that as president, he would be better than Biden on taxes and the economy. He said the corporate tax rate should be at 20%, at one point positing it could go as low as 15%, his campaign’s original target, according to a person who was there. (…)

Moynihan, more understated than Dimon, has criticized Biden’s policies as bad for business, based on conversations with the bank’s clients. He has told people that bank clients, many in the middle of the country, are complaining about Biden’s policies, specifically about permitting for energy projects and dealmaking.

Trump is happy to tell business leaders mostly what they want to hear. Besides more tax cuts, he has said he would be friendly to artificial intelligence and light on regulation, in particular for dealmaking. The Federal Trade Commission during the Biden administration has been among the most aggressive in recent years trying to block mergers and rein in giant companies.

But Trump’s policies in areas such as immigration and statements he has made that question the rule of law make businesses wary. On Thursday, he floated to House Republicans the idea—lacking in details—of an all-tariff federal revenue system, large enough to replace the income tax. (…)

Despite some CEO grumbling, businesses have thrived under Biden. Stocks are near records, corporate profits are up, inflation has come down and the economy has so far managed a soft landing despite aggressive interest-rate increases from the Federal Reserve. Industries such as energy that appeared to be at risk from Biden’s policies have done well. (…)

Mark Twain, totally unrelated to any of the above:

• “Sometimes I wonder whether the world is being run by smart people who are putting us on or by imbeciles who really mean it.”