Orlando's Outlook: Manufacturing Bounce Could Spark Inventory Re-stocking


Bottom Line Against the backdrop of a brutal winter and diminished end-market demand in the first quarter, businesses quickly slashed their inventories sequentially by nearly 60% to $45.6 billion, which represents their leanest level since their $42.2 billion trough in the first quarter of 2013. That’s understandable given the dreadful 2.9% decline in first-quarter Gross Domestic Product (GDP), the weakest such reading since the depths of the Great Recession. But it appears to us that manufacturing, which accounts for roughly 12% of overall U.S. economic activity, has begun to turn the corner, with improving auto sales, the ISM survey, capacity utilization and durable- and capital-goods orders and shipments, among other metrics. As a result, if we are right that second-quarter and second-half GDP bounces sharply from dismal first-quarter levels, then firmer end-market demand both here and abroad for manufactured goods should spark a much-needed inventory re-stocking cycle, perhaps building towards last year’s third-quarter inventory peak of $115.7 billion, which is nearly triple current inventory levels. 

Regional Fed manufacturing indices rebound All seven of the regional Federal Reserve indices we monitor have bounced sharply from their winter troughs, collectively indicating that conditions for manufacturers have improved in recent months. 

  • Empire manufacturing index Bottomed at 4.48 in February and rose to a two-year high of 19.3 in June.
  • Philadelphia Fed manufacturing index Surged to a surprisingly strong 17.8 in June, its highest reading since October 2013, up sharply from its February trough reading of a negative 6.3.
  • Richmond Fed manufacturing index Reported a sharp gain to 7 in May, up from a negative 6 in February, although it has since slipped to 3 in June.
  • Kansas City Fed manufacturing index Rose to 10 in May, up from 4 in February, although it fell to 6 in June.
  • Milwaukee purchasing manager’s index Bounced from 48.6 in February to 63.5 in May, before easing back to 60.6 in June.
  • Chicago purchasing manager’s index Leapt from 55.9 in March to 65.5 in May—its highest reading since October 2013—before sliding back down to 62.6 in June.
  • Dallas Fed manufacturing index Soared to 11.4 in June, up from 0.3 in February.

Auto sales soar In our view, auto sales remain a sustainable bright spot for the economy. After bottoming at 15.16 million annualized units sold in January—down largely due to winter weather issues—auto sales soared to an 8-year cycle high of 16.92 million units in June. That is an 88% increase from 9.02 million units at the cycle trough in February 2009. We believe that auto 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 seven and eight years. Customer financing remains plentiful. 

ISM manufacturing index improves The Institute for Supply Management’s (ISM) U.S. manufacturing index bottomed at 49.0 in May 2013, which implies “economic contraction,” before bouncing back to 56.5 in December to end the year on a positive note. But the ISM plunged to 51.3 in January 2014 due to the extreme winter weather. Since then it has rebounded sharply back to 55.3 in June, which puts the manufacturing index solidly back into expansion territory.

Industrial production and capacity utilization strengthen Industrial production rose by a solid 0.6% in May, marking its third solid sequential increase in the past four months. Capacity utilization rebounded to 79.1% in May, which is just off its 6-year cycle high of 79.3% in March. This represents a significant improvement from its 68.1% trough in June 2009—a record low that dates back to 1967—but we’re still well below the pre-recession peak of 81.2%. 

Durables and capital goods orders and shipments stronger Durable and capital goods orders and shipments rebounded strongly in March to their best levels since November 2013. While more recent April and May results have largely consolidated those sharp gains, manufacturing continues to improve in the aftermath of the difficult winter. Nominal U.S. durable goods orders soared by 2.6% and 3.7% in each of February and March before rising by an additional 0.8% in April and falling by 1.0% in May. Core durables (which exclude volatile transportation orders) rose by 3.0% in March, followed by a gain of 0.4% in April and a slight 0.1% drop in May. Nominal nondefense capital-goods orders (ex transportation) surged by 4.7% in March, followed by a decline of 0.4% in April and a gain of 0.4% in May. Core nondefense capital goods shipments (excluding aircraft) rose by 2.2% in March, before a 1.1% decline in April and a 0.7% increase in May. This last metric feeds directly into the second-quarter GDP report, so May’s strength will partially offset April’s weakness. 

Factory orders rebound After plummeting sequentially by 1.7% in December and 1.6% in January, U.S. factory orders bounced sharply over the past several months. They rose by 1.7%, 1.5% and 0.8% during February, March and April, respectively, before consolidating by 0.5% in May.

Steady wholesale & business inventories begin to accelerate U.S. wholesale inventories, which rose by a meager 0.2% in December 2013, climbed by 1.1% and 1.0% in March and April, respectively, before rising by 0.5% in May. Wholesale sales increased by 1.3% in April and 0.7% in May. Business inventories rose by 0.4% in each of December, January and March, but have begun to accelerate by a 0.6% pace in April.

Manufacturing getting back on track June added 16,000 jobs, up from May’s addition of 11,000 jobs, April’s gain at 9,000 jobs and only 4,000 new jobs in March. In contrast, February had added 20,000 jobs.

Trade balance starts to shrink After plunging in November 2013 to its lowest level in four years at negative $35.17 billion, the trade gap surged 34% over the next five months to its highest level in two years at negative $47.0 billion in April, largely due to declining exports. But those negative trends began to reverse themselves in May, as the trade gap fell by 5.5% to negative $44.4 billion. What caused this improvement? Exports rose by 1.0% in May to a record $195.5 billion, as economic growth has begun to re-accelerate among our overseas trading partners. That has been led by sales for autos and consumer goods. Imports slipped by 0.3% in May to $239.8 billion—just under April’s record $240.5 billion—as the demand for imported cars remains strong. For comparison purposes, the monthly trade balance deficit had troughed for this cycle in May 2009 at negative $26.0 billion. But this improved May trade deficit should begin to benefit second-quarter GDP.