Wednesday, 21 November 2012

US Industrial Weakness - The End of the Beginning

Conclusion: The US's industrial data has been exceptionally volatile over recent months: October's shocking 0.9% mom fall in manufacturing output is countered today by the strongest Markit manufacturing PMI since June.  But beyond the noise, there is genuinely good news: US industry and its buyers are seeking, and finding, an equilibrium which was seriously threatened earlier this year. The volatility may well continue, but the worst scenarios of industrial recession are in retreat - most probably, the worst we can now say is that this is the end of the beginning. 

Markit's US manufacturing PMI has too brief a history to be taken as definitive, but November's read of 52.4 implies the strongest expansion since June, and the details suggest that the strength is broad-based: output, new orders and employment all accelerated, whilst inventories of finished goods shrank work backlogs stagnated. Meanwhile, there are signs of supply-side stickiness, suppliers' delivery times lenthening the steepest since May and input prices jumping the most since March.

Whilst there will probably be more volatility to come, the uptick captured by the PMI shouldn't be ignored - there are good reasons to think that at the worst, this is the end of the beginning of this year's wave of US industrial weakness.

Understanding the dynamics of this year's weakness is the key to understanding why we are probably now exiting that phase. So consider the recent evidence: the industrial shocks fell thick and fast last week: industrial production fell 0.4% mom in October, with manufacturing down 0.9%, which dragged down capacity utilization rates to their lowest since November 2011. The news was exacerbated by a shockingly weak Philly Fed survey, a weakness in part reflecting the impact of Hurricane Sandy on production and orders. However, although those grabbed the headlines (and depressed sentiment), the news was not solely bad.
To understand why, consider the chart above, which tracks growth in output against growth in manufacturing and trade sales. Throughout much of the last year, the trend in sales has been declining relative to output. By June, we had finally reached the point where output was growing faster than sales – surely a herald of a production slowdown needed to restore equilibrium. This deteriorating supply/demand imbalance has led to recurring bouts of industrial weakness, of which September’s 0.4% mom decline was the latest manifestation.

But now look at the chart again: sales are now picking up both absolutely (manufacturing and trade sales rose 1.4% mom in September) and relative to production.

The picture is completed by taking into account movements in total inventories and exports. In September, both of these gave strong readings: total inventories rose 0.7% mom, and exports jumped 4.2% mom. When we compare the underlying 6m momentums of Output minus sales, plus inventories, and exports (see the chart below), we can see that neither the sharp excess of production over sales and inventories that was threatening by mid-year, nor the collapse of exports which also seemed likely, has come about. Back in June, the data threatened a repeat of 2001 and 2008-09. Despite, or perhaps because of, the volatility of industrial and trade data over the last few months, that threat has receded. 

Conclusion? Manufacturers and buyers are seeking, and beginning to find, an equilibrium. This doesn’t mean that US industrial weakness will quickly pass, or that volatility will end soon: but October’s output fall is more likely the end of the beginning than the beginning of the end – a suggestion buoyed by the unexpected strength of November's Markit PMI.

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