US Capital Goods Book to Bill - On the Brink

The 1.3% mom fall in Feb's orders for capital goods (non-def ex-air) threatens to snuff out a re-tooling cycle which, though currently feeble, has been the best bet for a swing factor to push 2014 GDP growth above the 2.7% of current consensus.

The arrival or absence of a proper capital goods cycle is the crucial swing factor for 2014 US GDP. In 2013, non-residential investment added just 0.31pps to the average GDP growth of 2.6% - ie, it accounted for just 12% of US GDP growth. This is a significant underperformance: since 2010, nonresidential investment accounted for 30% of US GDP growth, on average. It is also an underperformance which, if corrected, could be expected to add 0.3-0.5pps to 2014 GDP growth. As a result, the monthly durable goods orders data is currently among the most important in the world.

Feb's 1.3% mom fall was bad enough, but when taken in conjunction with the 0.5% mom rise in shipments, it threatens the tepid cycle already underway. It means that the nominal level of orders have once again very nearly fallen to the level of shipments. The orders/shipments ratio is a sort of crude book-to-bill ratio: in normal expansionary time, the ratio is comfortably over 1, but when it falls below 1 one can be fairly certain that the cycle is turning down. February's results have cut this ratio to 1.01, down from the 1.04-1.06 range which normally prevails in expansions. We're not yet there, and there's still time for things to improve, but it puts us on the brink of a capital goods downturn.

The sectoral details were also bad: machinery fell 1.5% mom, communications equipt fell 2.7%, electrical equipment fell 0.9% and computer products fell 0.5%. In the key machinery sector, although shipments rose 1.6% mom sa, when one strips out the seasonal adjustment, there was no growth at all in yoy terms. 

It is astonishing that the cycle could be about to peter out, because there are many excellent reasons to expect an acceleration of capital investment. First, a strengthening is long overdue. For every country I look at, I estimate changes in capital stock by depreciating all fixed investment over 10yrs, and I generate a signal for directional changes in return on that capital by expressing GDP as a product of  that capital stock (a sort of asset turns measure). On this basis, ROC in the US is currently about as high as during the peak of the early 1990s, but capital stock is still growing only 1.8% a year in nominal terms even though gross private fixed capital formation grew by an annualized 5.3% in 4Q13.  By historic standards, the recovery has been both feeble and late, and a rebound is well overdue. 

This is broadly confirmed by monthly industrial data, which shows that capacity utilization rates have recovered to 78.8% in February. This is half a standard deviation above the post-2000 average, and approaching the 79%-80% levels which formed the pre-crisis plateau during 2005-2008. Since there's no obvious disequilibrium between industrial supply and demand which might trigger any downturn in the short-term, utilization rates are likely to continue to grind higher, in the absence of accelerated capital spending. 

This may not be a problem for individual companies, but it is for the economy as a whole.  For the number of people employed rose by an average 1.7% yoy in 2013, which meaning that capital per worker is virtually static, as is output per worker deflated by capital per worker.  Plainly, the lack of investment is now a ceiling to productivity rises, and thus to the potential GDP growth rate. 

After all this, it is worth repeating: Feb's data puts the US capital goods cycle on the brink of a reversal. All things considered this is not only depressing, but counterintuitive.  The odds must remain good that March and subsequent months bring better news.