Puerto Rico defaults. Manufacturing picks up. Construction spending drops. Robo-car’s first fatality. Airbag recall, seriously. Road tripping on the Interstate Highway System; thanks Ike.
Financial Review by Sinclair Noe for 07-01-2016
DOW + 19 = 17,949
SPX + 4 = 2102
NAS + 19 = 4862
10 Y – .03 = 1.46%
OIL + .88 = 49.21
GOLD + 19.60 = 1342.30
SILV + .98 = 19.78
Puerto Rico defaulted Friday on debt that is supposed to be guaranteed by the Puerto Rican constitution. In other words, Puerto Rico was supposed to pay creditors who hold general obligation bonds before paying anyone else, even police. But Governor Alejandro García Padilla said: No. He argued that paying teachers, emergency personnel and other critical needs must come first. Puerto Rico did not make the $800 million payment to its bondholders due on July 1. Puerto Rico’s government says it is in a “dire” financial position with only about $350 million in cash on hand right now.
Puerto Rico’s default marks the first time that a state or U.S. territory has failed to pay general obligation bonds since the Great Depression. The default was expected, and thus isn’t causing much havoc in the wider bond market. The island is over $70 billion in debt. Congress passed a bill this week preventing lawsuits on the default and imposing strict financial oversight.
A default would force the three major insurers backing Puerto Rico’s debt to pay out as much as hundreds of millions of dollars to bondholders. Ambac Financial Group backs $122 million in Puerto Rico debt due Friday, company disclosures show. National Public Finance Guarantee backs $173 million in general obligation debt coming due Friday, records show. Assured Guaranty backs $428 million coming due in the third quarter, most of it also due Friday.
Bond yields are making record lows. Heavy overnight buying pushed longer-dated US yields down to record lows. The 10-year yield touched 1.37% and the 30-year yield hit 2.20% as money rushed into government debt amid further speculation of more easing by the world’s biggest central banks. Additionally, Japan’s 10-year yield sank to a record low of -28 basis points and the UK’s 10-year yield fell to its own all-time low of 78.1 basis points. Now, before all that money moves into the safe haven of US Treasuries, it must be converted into dollars. Immediately following last week’s Brexit vote, the dollar index spiked up about 3%, up 2.5% against the euro, and up 12% against the pound. That might not sound like much but in the currency exchange markets, those are really big moves. But since that initial response, the currency markets have started to consolidate.
The simple truth is that there are very few immediate consequences of Brexit; it will take time for this story to play out. It’s reasonable to expect the dollar to continue to attract safe haven moves; not because the US economy is particularly strong but because it will likely be stronger than the UK or Eurozone. While we can fret about a possible breakup of the Euro Union or even the UK – which may or may not happen – reduced trade in the UK will probably reduce productivity and cut economic growth by maybe 2 or 3%. Even though the UK is the seventh largest trading partner of the US, that is not enough to substantially torpedo US economic growth. It doesn’t help us but it is not a lethal blow.
Spending on construction dropped 0.8% in May, with weakness mostly concentrated in the public sector. A 1.8% monthly decrease in April was marked down to a 2.0% decline. Still, total spending during the first five months of the year was 8.2% higher than in the same period a year ago. Private outlays were 0.3% lower than April, while public spending was 2.3% lower. Residential spending was 5.3% higher.
The Institute for Supply Management (ISM) said its index of national factory activity rose to 53.2 from 51.3 the month before. A reading above 50 indicates expansion in the manufacturing sector and a reading below 50 indicates contraction. The employment index rose to 50.4 from 49.2 a month earlier. New orders climbed to 57.0 from 55.7. The prices paid index fell to 60.5 from 63.5.
U.S. safety officials have opened a preliminary investigation into 25,000 Model S cars after Tesla’s Autopilot recorded its first fatality. The incident, in which a man driving a Tesla Model S was killed in a collision with a truck in Florida, has prompted an investigation by federal highway safety regulators. Tesla said in a blog post that the crash was the first in the more than 130 million miles that the semi-autonomous driving system has been used. That compares with a fatality every 94 million miles for all vehicles in the United States. The company also said that customers were required to give “explicit acknowledgement” that they realize Autopilot is new technology still under development, otherwise the system will remain off. Drivers are also told that they are required to keep their hands on the wheel at all times.
The National Highway Transportation Safety Administration is also advising owners of 313,000 recalled Honda and Acura vehicles (from 2001-2003) to replace their Takata-made air bags immediately after testing showed there’s as high as a 50% chance of them rupturing in a crash. According to the regulator, eight of the 10 U.S. deaths caused by Takata air bags occurred in these models.
America’s Interstate Highway System is 60 years old this week. Back in 1919, Dwight Eisenhower struck out on a road trip across the country. His military convoy, the first to cross the US by car, was an effort to gather info on the state of American roads at the time. It averaged 52 miles per day. This road trip and a view of the German autobahns would plant the seeds of the future US Interstate Highway System. The Federal Highway Act of 1956 created the interstate highways and gave the United States incredible gains in mobility of personal travel and cargo shipments as new segments opened in state after state. It was a remarkable achievement that helped make the U.S. economy the world’s leader. And since President Eisenhower floated the idea, the highway system has grown to 47,856 miles of roads, bridges, ramps, and curves, the meshwork that defined American post-war expansion and exceptionalism. And this weekend those highways will be packed.
This July 4 weekend is expected to see the highest volume of travelers on record for the holiday, according to a report by AAA. Nearly 43 million people will be traveling between June 30 and July 4. The majority of travel will be done by car — 84% of travelers will take to the road as gas prices are expected to be the lowest since 2005 at an average of $2.32 a gallon. Thus far in 2016, American drivers have saved $20 billion in gasoline spending compared with last year, according to AAA. More than 3 million Americans are expected to fly and 3.3 million will take a bus, cruise, train or other mode of transportation.
Now, if you do travel on the highways this weekend, or any time, you are bound to notice that they are showing their age. In recent years the federal government has fallen behind on its maintenance budget by almost a third (spending $20 billion a year of a needed $33 billion). Congestion is on the rise and roads and bridges are often in disrepair. The Department of Transportation estimates that by 2030, we might have an annual $86 billion funding gap—and that’s just to keep those old highways and bridges functioning. Actually improving the infrastructure and making it really functional and productive could cost up $150 billion per year.
We know it is a good investment. For every dollar in gas tax revenue spent on highway maintenance, the government would save between $4 and $10 on future repairs. The infrastructure gap is a check on growth and a pernicious hidden cost of doing business. We consistently under-estimate the benefits of good roads and bridges – not to mention rail, canals, schools, and parks – and we over-emphasize the hassles and the costs. We are falling behind globally as a result.
One area that would seem to be prime for an upgrade is the construction industry itself. When it comes to big public infrastructure building and maintenance we seem to get stuck with projects that are over budget and late. A new report just released identified five trends disrupting the construction industry: higher-definition surveying and geo-location, next generation 5-D building information management software (including integration of augmented reality devices), digital collaboration and mobility, the Internet of Things and advanced analytics, and “future proof design and construction,” which spans from new building materials, such as self-healing concrete, aerogels, and nanomaterials, to innovative construction approaches, such as 3-D printing and preassembled modules.
The McKinsey Global Institute estimates that the world will need to spend $57 trillion on infrastructure by 2030 to keep up with global GDP growth. That should serve as some incentive for disrupting the construction industry. Yes it will cost money to maintain the infrastructure we have, and it will cost even more to upgrade and grow, but 60 years of the US Highway System have proven that this is an investment that pays much more than it costs. Conservative estimates claim that every $1 spent to build the Interstate has returned an estimated $6 of economic growth. That’s a rough guess; it’s almost impossible to measure the full impact.
Think about your own commute. Wouldn’t it be great if there were no more potholes, if every fifth bridge you crossed was not functionally obsolete, if the traffic lights were truly synchronized to keep you rolling along without interruption, and if you never got trapped in congestion again? Now multiply that by 200 million other drivers. Now consider that every year, $13.9 trillion in goods are shipped from sites in the US. The business of America is conducted on our roads; this is the lifeblood of the economy.
So, anyway, something to think about if you are heading out on a road trip this weekend. Have a happy holiday and a safe trip.