Inventory levels are too high… across all sectors. More critically, they have been surging for months, and are back to recessionary levels.
It’s a demand problem: a year-long decline in stagnant sales and new orders is accelerating.
We see the problem showing up everywhere, like durable goods production, which has been contracting for months.
What Comes Next
Why is demand slowing down? It’s the convergence of two waves: the US recovery is long in the tooth (6+ years) and China’s growth cycle peaked last year.
What really matters is the response in the supply chain. Manufacturers are not looking for a repeat of 2007 when they got stuck with excess inventories. Go back to the chart above and notice that, shortly after new orders plunged in 4Q 2014, factories took two actions:
- They pulled back production. Year over year growth in inventories went from 5% to 0% in a matter of months.
- They slowed hiring. Payroll growth dropped from 20K per month to (-17K) most recently.
Producers are very willing to move quickly to course correct and return to a profitable supply/demand equilibrium. The only way to address the inventory overhang is to cut back production, and that means a smaller workforce, otherwise known as layoffs.
A Trickle Turns Into a Flood
Recently layoff announcements have picked up:
- Deere (DE): 180
- US Steel (X): 1,100
- Century Aluminum (CENX): 500
- Johnson Controls (JCI): 197
- Freeport McMoran (FCX): 210 (the plan is to fire 10% of US workers)
- Fluor (FLR): 500
- Caterpillar (CAT): 475
US Steel is closing an Alabama plant and firing 1,100 workers by November 17th. According to the company, “This proposal was initiated after careful market analysis of the company’s current and long-term global operational footprint competitiveness.”
(That November date is important – we’ll come back to it.)
History Repeats: The Slowdown Trend Underway
As global (aka Chinese and US) demand growth has slowed, excess supply has grown and prices have dropped. The problems always manifest at the margins and in the commodities space.
The first domino to fall was oil. This year, oil companies have fired 70K+ Americans so far. Now layoffs are coming to the rest of the commodities space. Up next: the manufacturing space.
Layoffs will initially be a trickle. First, because companies imagine that fine-tuning payrolls will be sufficient. Second, because employers want to keep layoffs below 500 people – a threshold that triggers federal government engagement and mandated actions.
Many layoffs will also be unannounced, buried in the usual seasonal cutbacks. Starting in September, factory production begins to wind down. Shelves have to be stocked by October in time for the holiday season, so factories start to slow and lay off workers. This year, a few more will be added to the mix.
Moreover, companies like to hold back layoff announcements until earnings season. It plays out much better to balance bad news (sales are falling) with ‘good’ news (initiating cost savings). Wall Street likes get-well plans, which means bigger layoff announcements will come in late October.
Then we have holidays. Layoffs over Thanksgiving and Christmas make for bad PR. US Steel wants to complete the layoffs Nov. 17th, before Thanksgiving.
So, unless demand returns, expect that trickle of layoffs to become a flood in January when the holidays are over and earnings season begins again.
- September – October: Production cuts translate into reduced shifts and select payroll cuts. Wage growth and overtime will drop.
- November – December: Layoff announcements slow until after the holidays.
- January – February: Layoffs timed with earnings calls.
Bear in mind that I was one of the only forecasters on Bloomberg who correctly predicted last week’s sub-200K private payrolls announcement.
The Demand Problem Continues
The layoffs began to surface in oil, then metals, and now manufacturing (17K layoffs in August!).
The impact will be felt more broadly. The manufacturing sector employs 15x the manpower as in the oil industry, and manufacturing is important to a lot more states.
The oil sector cut 8% of its workforce. That’s equivalent to about 1M manufacturing workers. That’s just the potential direct cuts. Indirectly, retail and restaurants will suffer. I don’t foresee that level of cuts, but it gives a sense of scale.
The problem extends well beyond manufacturing. Making and selling stuff is a response to demand. Consumer demand is slowing – it’s still high but it just isn’t growing as much; which means all economic sectors will be facing slower demand.
Now factor in the stock market and consumer sentiment. The market is down 10% and hasn’t budged for weeks. For the first time in five years, nobody is buying the dip. If the market remains low through September, consumer spending will drop. That further pushes down economic growth.
Playing It Out
Look for a tentative 25K+ layoffs over the next two months (Phase 1), followed by a bigger (50K) level of cuts announced in 1Q 2016.
The slowdown has begun. It is a simple cyclical trend. Not to mention, the Fed is seriously talking about raising rates.