The market sunk again last week due to new worries about Europe and a string of terrible economic news on Thursday. The European situation was compounded by the fact that European GDP growth crawled to a virtual standstill during the second quarter, much as it may have in the United States. These slower growth rates will make it even more difficult for Europe to deal with its intractable debt crisis.
Outside the strong industrial production number on Tuesday, the economic data points released were amazingly consistent and crummy, at least on the surface. Peeling back the layers of the reports, the data points were still bad, but not nearly as bad as bad last week's market action would suggest. Last week's news stood in stark contrast to the data points from two week ago, including better initial unemployment claims and retail sales that showed an improving trend (this Tuesday's weekly retail data continued to show decent growth in face of crumbing financial markets). Poor regional purchasing reports, falling existing home sales, and a jump in consumer prices all overwhelmed the market on Thursday.
Despite last week's data, I suspect that the economy won't move into another recession (without some help from our politician friends). Auto production continues to rebound, gas prices are falling again, and Boeing (BA) just might make the second half look a little better as new jetliners finally roll off the production line. My biggest fears are that we will talk ourselves into another recession and falling stock markets will affect consumer spending at the high end, heretofore an area of strength. (However, the evidence that falling stock markets crater consumer spending is pretty thin; effects on spending were minimal after the Nasdaq collapse in 2000/2001 and the one-day 25% crash in 1987. But the profile of consumer spending has shifted to the high-end spender during the ensuing years, potentially amplifying the effects of a falling stock market.)
Regional Purchasing Managers' Report and Industrial Production Paint Different Pictures
To add more confusion to the manufacturing picture, industrial production showed its third monthly increase in July after weakness earlier this spring. The table below shows the trend well:
Industrial Production Looks Good but Weather and Autos Helped
Based on real production, it appears the time to be worried about manufacturing was this past spring. Since then both the monthly data and year-over-year data have shown improvement. While the ups and downs can at least partially be explained by Japanese supply chain issues, the numbers are still trending the right way when excluding autos. I suspect August will not be quite as strong (autos provide less of a rebound) but I still expect a positive number.
PMI Is a Hyperactive Indicator
I have also posted the much-heralded Purchasing Managers' Index (PMI) numbers that looked relatively strong before the spring slowdown and then collapsed in front of the recent acceleration. While the PMI is useful at market bottoms, it is less so during a normal recovery and when the economy is particularly volatile. The PMI indicator tends to have some false positives; during the 1990s this indicator flashed four signals that produced exactly one recession. It does a better job predicting industrial production than the overall economy, but in the short run even that relationship isn't perfect--as the chart above indicates.
Regional PMI Data Looked Terrible, Not Necessarily the End of the World
A pair of very negative regional PMI reports (Philly Fed and Empire State) particularly unnerved the markets last week. The Philly Fed report fell to negative 30, a number normally associated with recessions. (This means the percentage of firms reporting declining results exceeded those that saw improving conditions by 30% and excluded those reporting flat conditions. Almost all the readings of this index are in a range of negative 40% to positive 40%). The reading from the Empire State was less damaging at negative 7.7%. These regional reports are even more volatile than the national report and have also forecast many more recessions than have actually occurred.
So What's Really Going on in Manufacturing?
A short-term rebound in the auto industry and more favourable weather conditions are probably behind some of the relatively strong industrial production numbers of late. The regional PMI data is probably hurt by the way it's gathered. A lot of the regional reports are an up-or-down question on overall conditions and at least quasi-subjective (versus the national survey, which is an objective average of several different measures). The two regional surveys were taken in early August when the deficit-related crisis was at its worst, potentially influencing the more subjective overall rating (individual categories were negative, but the biggest negative number was the overall reading).
The Economy Is Neither as Strong as Industrial Production Suggests or as Weak as PMI Reports Purport
The reality is that export sales, while still strong, aren't growing nearly as fast as they were a year ago. One major manufacturer indicated that export sales are now growing at a 25% rate now versus 50% at this time a year ago. That's hardly anything to sneeze at, but it's still a lot slower than it was. In addition, the inventory replenishment cycle coming out of the recession has also run its course (except in autos), which also may be responsible for some of this apparent slowing in the manufacturing sector. Finally, with prices now beginning to fall, the big push to get orders in before further price increases are implemented is probably well behind us, too.
