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Orlando's Outlook: Restocking could spark second-half manufacturing rebound

As of 07-12-2013

Bottom Line Amidst a decidedly below-trend period in Gross Domestic Product (GDP) growth over the past three quarters, manufacturing—which accounts for roughly 12% of overall U.S. economic activity—has stuck out like a sore thumb as the stronger dollar, European recession and decelerating emerging-market economies have collectively impaired U.S. exports. But we may be close to a positive inflection point, with improving economic activity in such key manufacturing metrics as the ISM survey, auto sales and factory orders suggesting manufacturing may have already hit bottom. Moreover, the Commerce Department this week reported wholesale inventories in May fell by a worse-than-expected 0.5%, the largest monthly decline since September 2011. But the kicker is that May sales surged by a much stronger-than-expected 1.6%, which was the largest gain in six months. So with businesses intentionally depleting their inventories to their leanest levels since April 2012, if we’re right that second-half GDP will be stronger than tepid first-half levels, then that firmer end-market demand for manufactured goods will likely spark a much-needed inventory restocking cycle, which should help to boost GDP growth to perhaps an annual 3% run rate by year-end. 

ISM manufacturing index strengthens After plunging from a healthy reading of 54.2 in February, the Institute for Supply Management’s (ISM) U.S. manufacturing index plunged to 49.0 in May, which implied economic contraction. But the ISM rebounded sharply to 50.9 in June, which puts the manufacturing index back into expansion territory. 

Auto sales drive higher Auto sales remain one of the economy’s true bright spots.  After some softness during March and April, consistent with our “Spring Swoon” economic forecast, sales have resumed their ascent, soaring by 76% from 9.02 million units at the cycle trough in February 2009 to 15.89 million units annualized in June. While this level is well above replacement demand at 14.0 million units, we believe sales will continue to grind higher for some time, as the average age of the U.S. auto fleet is now just under 11 years-old, compared to a normal average age of between 7- and 8-years old.  To help facilitate further sales improvement, plentiful customer financing is at its best level in more than six years. 

Factory orders rebound After plummeting by 4.7% in February, U.S. factory orders have bounced sharply over the past two months, rising by an upwardly revised 1.3% in April and a stronger-than-expected 2.1% in May. 

Wholesale inventories drop U.S. wholesale inventories surprisingly declined by 0.5% in May, falling by the most since September 2011, and April was revised down to a 0.1% decline for the month.  Against this backdrop of inventory depletion, however, wholesale sales surged by a much stronger-than-expected 1.6% in May, on the heels of an upwardly-revised gain of 0.7% in April. While these inventory metrics will surely hurt second-quarter GDP (to be flashed on Wednesday, July 31), if the strong current pace of sales is maintained in coming months, we expect a surge in wholesale inventory re-stocking, which could boost second-half  GDP. 

Manufacturing payrolls weak U.S. manufacturing payrolls lost jobs for the fourth consecutive month in June despite a general firming in the labor market. The manufacturing sector lost 6,000 jobs after losses of 7,000 in each of April and May and 4,000 lost jobs in March. The 23,000 jobs gained in February 2013 marks the last period where manufacturing saw an increase in employment, so there’s plenty of positive leverage to the labor market if manufacturing begins to improve. 

Trade balance widens The U.S. trade deficit surged in May by 12.1% to $45 billion, its widest level since last November and the largest month-over-month jump in two years as imports climbed to their second-highest level on record while exports slipped. Imports climbed 1.9% to $232.1 billion (just below the record $234.3 billion in March 2012), due to stronger U.S. demand for foreign autos, mobile phones, energy and household goods, as consumer confidence has strengthened to a six-year high in recent months. While exports decreased by 0.3% to $187.1 billion, much of the decline was driven by a $1.13 billion decrease in U.S. gold purchases from foreign buyers, as well as softer demand for gems and jewelry. So while this decline in exports will certainly hamper second-quarter GDP, we believe that this trend will reverse in the second half of 2013, providing a boost to GDP growth. 

Industrial production and capacity utilization treading water Industrial production was unchanged in May on the heels of a 0.4% decrease in April, its largest drop in eight months, as the automatic spending sequester cut government spending and as overseas demand remained weak both from Europe and the emerging markets. Capacity utilization is at 77.6% for May, down from 78.3% in March. While this still represents a significant strengthening from its 68.1% trough in June 2009—a record low that dates back to 1967—we’re still well below the pre-recession peak of 81.2%. 

Durable and capital goods firming Nominal U.S. durable goods orders soared by 3.6% in each of April and May, compared with a sizable 5.9% decline in March, while core durables (which exclude volatile transportation orders) rose by a stronger-than-expected 0.7% in May on the heels of an even stronger gain of 1.7% in April, versus a 1.7% drop in March. Nominal nondefense capital-goods orders (ex transportation) rose by 1.1% in May and by 1.2% in April, slightly stronger than March’s solid pace of a 0.9% gain. Core nondefense capital goods shipments (excluding aircraft) rose by a surprisingly strong 1.7% in May, which nearly reversed a 2.1% decrease in April. This last metric feeds directly into the GDP report, so May’s strength will partially offset April’s weakness, and hopefully lay a substantial foundation for stronger second-half 2013 GDP growth.

Regional Fed manufacturing indices improving Among the seven regional Federal Reserve indices that we monitor, six of them were positive in June, and five of them enjoyed month-over-month improvement, as only Chicago and Kansas City reported sequential declines. This collectively indicates that conditions for manufacturers have improved in recent months. 

  • Empire State manufacturing index Rose to a three-month high of 7.84 in June from a negative 1.43 in May.
  • Philadelphia Fed manufacturing index Surged to a surprisingly strong 12.5 in June, its highest reading since April 2011, up significantly from its May reading of negative 5.2.
  • Dallas Fed manufacturing index Soared to a much stronger-than-expected gain of a positive 6.5 in June, which was a three-month high, from  a negative 10.5 in May and a negative 15.6 in April.
  • Richmond Fed manufacturing index Reported a sharp gain to a positive 8 in June, which was its highest reading since November 2012, from a negative 2 in May, a negative 6 in April and a negative 12 in January. 
  • Milwaukee purchasing manager’s index Boasted a stronger-than-expected gain to 51.55 in June, which is a four-month high, from 40.67 in May.
  • Kansas City Fed manufacturing index One of two disappointments, Kansas City inexplicably fell to a negative 5 in June, which was comparable to March and April levels, down from a positive 2 in May. KC was a negative 10 in February, so this region is making some choppy progress.
  • Chicago purchasing manager’s index Surprisingly decreased to a positive 51.6 in June from a positive 58.7 in May, which had been Chicago’s highest reading since March 2012.  So while this clearly represents a setback for one of the more important regional Fed indices, perhaps Chicago is experiencing some consolidation at present, before it resumes its ascent in the second-half of 2013.    

 Research support provided by Federated Investors intern Matthew Flanagan

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.
Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.
The Chicago Purchasing Managers Index, produced by the The National Association of Purchasing Management–Chicago, gauges factory health in the upper Midwest based on surveys of companies in that region.
The Empire State Manufacturing Index gauges the level of activity and expectations for the future among manufacturers in New York.
The Federal Reserve Bank of Dallas' monthly Texas Manufacturing Outlook Survey is a measure of the current level of activity and expectations for the future.
The Federal Reserve Bank of Kansas City surveys manufacturers in its district monthly to gauge the level of their activity.
The Federal Reserve Bank of Philadelphia gauges the level of activity and expectations for the future among manufacturers in the Greater Philadelphia region every month.
The Federal Reserve Bank of Richmond Monthly Manufacturing Survey survey is a gauge of activity and expectations for the future among manufacturers in its district.
The Milwaukee Purchasing Managers Index, produced by the The National Association of Purchasing Management–Milwaukee, gauges factory health in the upper Midwest based on surveys of companies in that region.
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