If you're looking for concrete signs that the economy is getting back on its feet, check out the recent encouraging reports from the manufacturing sector. The factory recession, which began last autumn, has been a huge drag on economic growth. Now, manufacturing is starting to firm up, and that's a big plus for the outlook.
Analyzing the factory data, however, requires care. Makers of tech equipment show no improvement at all, with little hope for a turnaround anytime soon. Tech orders and output are still falling, and inventories remain way out of balance with demand.
Despite tech's heavily skewed impact on the overall data, though, the other 90% of U.S. manufacturing is finding firmer footing. In particular, the August report from the nation's purchasing managers, which shows improvement in industrial activity, corroborates recent government data showing that output and demand are stabilizing, and that inventory excesses are shrinking.
At the same time, overall demand in the third quarter is holding up. The problem is that spending is still proceeding down two different tracks: Consumer buying continues to grow at a moderate clip, while business investment, especially in tech equipment, is declining. That's why the tech sector of manufacturing is weighing so heavily on overall industrial activity.
THE MOST UPBEAT NEWS from manufacturing comes from the National Association of Purchasing Management's August survey. The purchasing managers' index--a composite of orders, output, employment, inventories, and delivery speeds--posted a surprisingly strong increase, to 47.9%, up from 43.6% in July (chart). The monthly gain was the largest in five years, and the level was the highest since last November.
The index remained below the crucial 50% mark, which is the dividing line between recession and expansion in the factory sector, but two key component indexes--orders and production--popped over the 50% line. The purchasers are saying that both demand and output actually increased for the first time since last year. Indeed, the forward-looking orders index in August rose to its highest level since April, 2000.
The NAPM report is the best sign yet that the worst of the slowdown has passed. The trade group says that the August level, if maintained, is consistent with 1.9% growth in real gross domestic product. The stock market, with its mind-set that good news on the economy is good news for future profits, soared on the NAPM's news on Sept. 4, but it fell back later in the day as investors registered thumbs down over the proposed Hewlett-Packard-Compaq merger (page 40).
The report also suggests that manufacturers have made great strides in eliminating their excess inventories. The 13% of purchasers saying their customers' inventories are "too high" remains far below the January peak of 26%. And for the third month in a row, more purchasers said that inventory levels were "too low" than "too high." That's a good sign for ordering and output in coming months.
The latest government data on manufacturing orders, which runs through July, also offers some hope. Despite a 0.7% drop in durable-goods orders in July, total orders edged up 0.1%, thanks to strong gains in bookings in nondurables and consumer goods (chart). The weak spot: capital equipment, where nondefense, nonaircraft orders fell for the sixth month in a row.
THE DRAG ON ORDERS coming from the tech sector has been enormous. Tech bookings are only about 10% of overall orders, but during the past year, they have accounted for about half of the 7.3% drop in factory orders. Since January, total factory orders are down 1.1%, but excluding tech bookings, they are up 1.4%.
The skew from the tech sector is also evident in the inventory data. The overall ratio of inventories to sales in manufacturing in July was not much lower than it was at the beginning of the year. But excluding tech manufacturers, the ratio has declined noticeably in recent months.
The reason for the tech inventory problem is that manufacturers aren't cutting their stockpiles fast enough. Since January, tech inventories have shrunk by 6.8%, but shipments have plunged 19.3%. The inventory overhang is not a good sign for stronger output anytime soon. The tech wreck will hamper economic growth for months to come, but the latest factory data imply that tech alone will not prevent at least a modest recovery from taking root.
EVEN SO, an upturn will depend on consumers who, so far, are willing to keep the economy afloat. Indeed, while capital-goods orders are down 15% since January, bookings for consumer goods, which are twice the size of capital goods, are up slightly. Equally important, consumer buying should soon get a powerful boost from Washington.
In July, price-adjusted household buying rose 0.2%. If buying continued at that pace for August and September, then real consumer spending would grow at an annual rate of 2.5% this quarter, the same advance posted in the second quarter. That pace, while modest, was still large enough to more than offset the drag on second-quarter growth from the plunge in business spending on capital equipment.
Spending could pick up, however, because incomes are getting a boost from the tax rebate and tax cut. Aftertax income jumped 1.7%, or $128 billion, from June to July (chart). The Commerce Dept. said that $95.1 billion of the gain was the result of rebate checks and the reduction in tax withholdings. Since the tax checks only began hitting consumers' mailboxes on July 20, the income gain in August will be even greater.
Plus, capital gains remain a source for spending. In a speech at the Federal Reserve's annual symposium in Jackson Hole, Wyo., Chairman Alan Greenspan said that wealth from all sources "appears to explain one-fifth of the total level of consumer outlays."
Rising home prices have generated a big chunk of that wealth. When a house is sold, Greenspan said that 10% to 15% of the capital gain goes to new consumer spending. He also said "a considerable amount of cash is extracted" from refinancings and home-equity loans. And refis remain quite popular, thanks to mortgage rates below 7%. In August, mortgage applications for refis were up by a large 32.5% from their July average.
Clearly, the economy is caught between the downward forces of the tech meltdown and the upward pull of a steadfast consumer sector. That tug of war means any recovery in the manufacturing sector will be painfully slow. But thanks to the lift from Washington and a resilient housing market, consumers now have the upper hand. And chances are improving that factories--and the overall economy--will be a lot healthier by early next year.
By James C. Cooper & Kathleen Madigan
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