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Today's
Market WrapUp 06.20.2007 Mon
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Puplava Archive
Industrial Production Release Points Towards
Continued Economic Weakness
BY CHRIS PUPLAVA
Last
Friday the Federal Reserve released the industrial production numbers
for May, which showed stagnant growth with zero growth over April’s
levels and capacity utilization falling two-tenths of a percent to
81.3%.
Figure
1
Source:
Moody’s Economy.com
What
I would like to point out is the weakness in industrial production and
capacity utilization in the current economic cycle compared to those
of the past half century. Both industrial production and capacity
utilization are already coming down from their highs this cycle while
never surpassing or even reaching the levels of the past cycle. The
reason this is important is to put to task the whole argument that
businesses will come to the economic rescue and increase capital
investment to offset slower consumer spending and a housing recession.
Here’s
a simple question. Why would corporations increase their capacity
through capital investment when the economy is currently not running
at full capacity to begin with, nor at peak capacity levels seen in
previous economic cycles at the same time the consumer is slowing
demand?
Need
proof of a consumer slowdown? Just take a look at consumer plans for
purchasing big ticket items and their optimism levels, not to mention
what small business owners are saying in their optimism polls.
Consumer plans to purchase homes and automobiles over the next six
months are declining with plans to purchase autos falling to a new
low.
Figure 2
Source:
Moody’s Economy.com
Corporations
are paying close attention as consumer durable goods industrial
production (automotive products, computers & electrical equipment,
appliances, furniture) is slowing, while nondurable consumer goods
industrial production (food & tobacco, clothing) remains strong.
The
relative rates of durable goods production to nondurable (essential
items) production is a good indicator of economic health. When the
economy is strong, consumers increase purchases on big ticket items
and conversely, when the economy is weak they continue spending on
essential items (nondurable goods) while reducing demand for durable
good items. For this reason, the ratio of durable goods to nondurable
goods production often turns south prior to recessions as seen in
Figure 3 below, and also follows the trend in the yield curve with a
16 month lag.
Figure 3
Source:
Moody’s Economy.com
The
housing slowdown is clearly weighing on small business owners' minds
as seen in Figure 4, and automobile production is likely to fall
further when looking at the correlation to the yield curve, indicating
weak auto demand out to next year (Figure 5).
Figure 4
Source:
Moody’s Economy.com
Figure 5
Source:
Moody’s Economy.com
The
slowdown in consumer spending appetites (retail sales) is quite
visible after peaking in early 2006, and has turned south sharply
following the bursting of the housing bubble. This trend will likely
continue heading south if retail sales follows its historical relation
to the yield curve as it has in the past, as the yield curve leads the
trend in retail sales by roughly two years (advanced in chart below).
The trend in the yield curve indicates retail sales will continue to
decelerate until bottoming in the first quarter of 2009, as the yield
curve is just now beginning to normalize with long-term interest rates
moving northward.
Figure 6
Source:
Moody’s Economy.com
It’s
not hard to envision why retail sales will continue to decelerate when
looking at the current housing situation that is far from bottoming
and continues to weigh on households for quarters to come. On Monday
the National Association of Home Builders (NAHB) released their June
Housing Market Index, which fell to 28 as every component of the index
was down, with the traffic of prospective buyers index falling to 21,
the lowest reading in more than 16 years.
Figure
7
Source:
Moody’s Economy.com
Revealing
the bleak outlook on housing is commentary provided by DismalScientist
below:
The
bottom of the housing market is unlikely to occur this summer or fall.
The record low numbers for the June survey begs the same question that
the record low numbers for April and May did, “can the housing
market get any worse without a recession?” The non-seasonally
adjusted profile of home builders who recorded optimism for the
traffic of prospective buyers index is so low that one wonders which
builders are prospering during this housing market.
The
fed funds rate may be too high for this sector to recover in the
current economy. One concern is the rising number of bankruptcies and
other insolvency issues for subprime lenders. A number of mortgage
originators have been required to buy back defaulting loans or close
their doors. There is little evidence that the expected return on
these “junk” mortgages justified the risk, so much tighter lending
practices are evident this year. Tighter lending standards will lower
the demand for single family housing, making it difficult to work off
the already high levels of inventory.
With
such a negative housing backdrop, it’s understandable why retail
sales are falling and consumers are ratcheting down their plans to
purchase big ticket items. With this being the case it’s not
surprising to see industrial production falling, not rising as many
financial pundits claim would happen as corporations are flush with
cash.
As
the shape of the yield curve affects consumer spending by increasing
the cost of borrowing and shows a significant correlation with a lag
of two years, it makes sense for the yield curve to affect business
spending by raising their cost of borrowing. As the trend in the yield
curve points towards deceleration in retail sales, so does the yield
curve with industrial production, putting a kink in the argument of
business spending picking up in the near-term.
Business
equipment industrial production has clearly peaked on a year-over-year
(YOY) basis and lags the shape of the yield curve by one year,
indicating continued weakness for the rest of the year.
Figure 8
Source:
Moody’s Economy.com
Overall
manufacturing industrial production has peaked with continued
deceleration ahead as indicated by the yield curve. Investment
spending is unlikely to increase as manufacturing capacity utilization
is well below previous highs and has displayed a series of lower peaks
in utilization rates over the last fifty years as the U.S. has shifted
away from a manufacturing economy to a service economy.
Figure 9
Source:
Moody’s Economy.com
Figure 10
Source:
Moody’s Economy.com
Don’t
expect spending on technology to make any headlines either as capacity
utilization for computer and technology equipment production is well
below peak levels and has already begun to roll over.
Figure 11
Source:
Moody’s Economy.com
In
short, businesses are unlikely to be the economic miracle to offset a
bursting housing bubble and weakening consumer spending in the near
future based on decades of historical precedence in the relationship
of industrial production and the shape of the yield curve. With
housing in the midst of a recession, consumers retrenching, and
businesses unlikely to step up to the plate, the dismal first quarter
GDP number may be the beginning of a trend in weak economic
performance, not a one-time event. So what does Wall Street see that
Main Street is missing?
TODAY'S
MARKET
The
markets moved southward despite falling energy prices as rising
interest rates sent jitters through the markets once more. The Dow put
in a triple-digit loss on the day, falling 146.00 points (-1.07%) to
close at 13,489.42, while the S&P 500 fell 20.86 points (-1.36%)
to close at 1512.84 and the NASDAQ closed at 2599.96, down 26.80
points (-1.02%).
Investors
sold Treasuries today with the 10-year note yield rising 3.7 basis
points to close at 5.123%. The dollar index was up on the day, rising
0.06 points to close at 82.60. Declining issues represented 75% and
69% for the NYSE and NASDAQ respectively, with down volume
representing 76% and 78% of total volume on the NYSE and NASDAQ,
reflecting a strong selloff in the markets.
Energy
prices took a beating after a strong build in petroleum inventories.
West Texas Intermediate Crude (WTIC) fell nearly a dollar a barrel
(-1.32%) to close at $68.19 a barrel. Precious metals were down on the
day with gold closing at $654.75/oz (-1.03%), with silver down
$0.15/oz to close at $13.19/oz (-1.12%). Base metals were mixed with
lead putting in the strongest positive performance (+2.99%), while
nickel displayed the weakest performance (-1.30%).
Overseas
markets were mixed up with the Taiwan Taiex index putting in the
strongest performance (+2.13%), while other Asian and European markets
were down more than one percent, with the Chinese Shanghai index down
the greatest, falling 2.07%.
The
selloff in the markets was broad based as all ten of the S&P 500
sectors were down on the day, with the consumer discretionary and
consumer staples sectors holding up the most, down 0.27% and 0.60%
respectively. Energy took the brunt of the selloff on the news of a
strong build in petroleum inventories, falling 2.93%, while rising
interest rates weighed on the utility and financial sectors, down
2.57% and 1.68% respectively.
Chris Puplava
Copyright © 2007 All rights reserved.
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PFS Group
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