Thursday, August 8, 2013

Will the Second Half Print Strong Growth?

There's a lot of very conflicting information on the US economy right now.  On the negative side we have the sequester and the potential for yet another government shutdown or threat thereof.  Wage growth is weak, higher interest rates are hurting the housing recovery and the employment situation is marginal at best.

But two reports last week hint at a far stronger economic environment in the second half.  Let's start with the ISM manufacturing report.

The PMI™ registered 55.4 percent, an increase of 4.5 percentage points from June's reading of 50.9 percent. June's PMI™ reading, the highest of the year, indicates expansion in the manufacturing sector for the second consecutive month. The New Orders Index increased in July by 6.4 percentage points to 58.3 percent, and the Production Index increased by 11.6 percentage points to 65 percent. The Employment Index registered 54.4 percent, an increase of 5.7 percentage points compared to June's reading of 48.7 percent. The Prices Index registered 49 percent, decreasing 3.5 percentage points from June, indicating that overall raw materials prices decreased from last month. Comments from the panel generally indicate stable demand and slowly improving business conditions."

What is particularly encouraging here are the internals; new orders jumped 6.4 points and the overall production index increased 11.6 points.  Usually these numbers increase in far smaller increments. Also of importance is the fact that 13 of 18 industries are reporting an higher activity.  Let's take a look at the anecdotal comments from the report:
  • "Business conditions remain stable, possibly improving somewhat in future months." (Miscellaneous Manufacturing)
  • "Housing market continues to improve, leading to increased demand in product." (Electrical Equipment, Appliances & Components)
  • "Overall conditions remain steady and slightly above prior year." (Paper Products)
  • "Sales are holding steady. Business is good." (Furniture & Related Products)
  • "Business is slow compared to previous years." (Computer & Electronic Products)
  • "First half [of 2013] is better than last year — steady, slow improvement." (Printing & Related Support Activities)
  • "Leading indicators continue to show stagnant-to-gradual improvement, and sales across the board continue to be flat." (Machinery)
  • "Economy continues to be relatively flat. Growth in China is holding. Europe staying at a low level, and U.S. just flat." (Transportation Equipment)
  • "We see gluten-free industry to be strong and it continues to grow. We also see the need for capacity in blending operations." (Food, Beverage & Tobacco Products)
  • "Business remains flat. Looking for some seasonal bump as we come to the beginning of our 'busy' time." (Chemical Products)
The vast majority of the comments are positive; only computer and electronic parts, transportation equipment and chemical products are slow.

Here's a graph of the overall data:

 The chart above shows the overall trend for manufacturing was decreasing for about a year, with several recent readings below the 50 line the delineates between expansion and contraction.  However, the latest reading is incredibly strong relative to the recent trend. 

Let's turn to the services index:

"The NMI™ registered 56 percent in July, 3.8 percentage points higher than the 52.2 percent registered in June. This indicates continued growth at a faster rate in the non-manufacturing sector. The Non-Manufacturing Business Activity Index increased substantially to 60.4 percent, which is 8.7 percentage points higher than the 51.7 percent reported in June, reflecting growth for the 48th consecutive month. The New Orders Index increased significantly by 6.9 percentage points to 57.7 percent, and the Employment Index decreased 1.5 percentage points to 53.2 percent, indicating growth in employment for the 12th consecutive month. The Prices Index increased 7.6 percentage points to 60.1 percent, indicating prices increased at a significantly faster rate in July when compared to June. According to the NMI™, 16 non-manufacturing industries reported growth in July. Respondents' comments are mostly positive about business conditions and the overall economy."

As with the manufacturing index, we see large increases in the internals with large jumps in overall activity and new orders.  Employment did drop, but it was still in positive territory.  And the breadth of the increase is impressive with 16 industries reporting growth.

Let's turn to the anecdotal part of the report:
  • "The economy seems to be getting stronger with commodity prices increasing." (Information)
  • "Sequestration and healthcare reform causing uncertainty and lower revenues." (Health Care & Social Assistance)
  • "Business orders continue to grow, but at a slow pace. We are seeing growth in areas where we have been flat for many months. Economy seems to be stabilizing in some areas and heating up in others." (Professional, Scientific & Technical Services)
  • "The auto industry continues to be strong, and we expect it to continue throughout 2013." (Retail Trade)
  • "Competitive environment remains challenging." (Accommodation & Food Services)
  • "Local business continues at same pace as last year. Capital investment continues to be positive." (Wholesale Trade)
As with the manufacturing report, the overall tenor of most comments is positive. We see a negative contribution from political and regulatory developments along with concerns related specifically to the hotel and restaurant industry.

Here's a graph of the data:

The service industry has been far steadier over the last few years, consistently printing numbers above 50 with little indication of a move into contraction.  However, the latest print is very strong.

Let's combine the above information with this statement from Dr. Ed:

My “Second Recovery” scenario is playing out nicely this year as rising auto and new home sales boost manufacturing and the overall economy. Railcar loadings of motor vehicles rose to another cyclical high in mid-July. This series is highly correlated with auto sales. The same goes for railcar loadings of lumber and wood products, which is highly correlated with housing starts. 

Auto sales numbers have flown below the headlines for the last few years, but the overall pace has been continually increasing:

Now auto sales are just below the average level they maintained during the last expansion.

The housing story may be starting to fade as higher interest rates may be slowing sales of both new and existing homes.

In reality, I remain very sanguine about the economy.  Every time it looks like we're about to kick into a higher gear, we see an extraneous event perpetrated by the the Republicans in Congress that hinders growth.  It started with the near default of US debt two years ago followed by the S&P downgrade, was followed by last year's sequester and will probably continue this year with yet more high level conservative budget stupidity.   And while the recent ISM numbers are very encouraging, they are in fact only one month worth of data and need to be understood as just that.  It's just as possible that next month we'll be disappointed with a far weaker than anticipated read. 

However, the numbers printed above highlight that -- yet again -- the economy appears to really want to grow faster.  Both primary sectors of the economy are printing strong numbers and auto sales are solid, indicating there is a certain level of consumer confidence in the market.  And while housing may be weakening due to higher interest rates, it's highly doubtful it will crater anytime some.  It's also possible that as the market adjusts to the new "higher" levels, they'll realize they aren't in fact that high and will still attract buyers in the market.  And finally, with the UK mending and the EU probably coming out of recession, it's likely that we'll see a rise in export orders which will obviously help the US economy, albeit it around the fringes. 

But, frankly, I'm expecting another round of Washington stupidity after the August recess that will put the kabash on the whole thing.