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Manufacturing Stalls


Judging from what we know about capital spending, the spreading contagion in housing, and recent upticks in initial unemployment claims, manufacturing optimism is simply unwarranted at this time.


The Philly Fed Business outlook Survey April 2007 has been released.

The index for general activity was near zero, and indicators for new orders, shipments, and employment were only slightly positive, suggesting little change from March. Regarding future activity, the region's manufacturing executives were somewhat more optimistic this month than they were in March.

Growth in Manufacturing Stalled

The survey's broadest measure of manufacturing conditions, the diffusion index of current activity, was unchanged at 0.2 this month.

Demand for manufactured goods, as represented by the survey's new orders index, reflects virtually no growth again this month. The new orders index, at 2.8, was only one point higher than in March, and the shipments index fell almost three points, to 4.3, suggesting little change from last month. Indexes for delivery times and unfilled orders remained negative, indicating shorter delivery times and a decline in unfilled orders.

Cost Pressures Remain

Area manufacturers reported higher costs for inputs again this month. The prices paid index edged three points higher and has now increased for three consecutive months. Thirty-seven percent of the firms reported higher input prices, up seven points from March; 13 percent reported lower input prices in April.

Despite increased costs, fewer firms reported higher prices for their own goods this month: 17 percent reported higher prices, down nine points from March. The prices received index fell 11 points, to 5.2, its lowest reading since August 2005.

Six-Month Forecasts Improve

The outlook for manufacturing growth over the next six months showed some improvement this month. The future general activity index increased from 17.4 to 25.8, the highest reading since April 2006.

The indexes for future new orders and shipments remained near their readings in March. Forty-one percent of the firms expect increases in new orders over the next six months; 42 percent expect increases in shipments.

The most significant factor in the report is cost pressures. Commodity prices have been rising but there has been no pass through of those costs. I keep hearing that rising input costs must be passed on. I keep seeing otherwise. This indicates falling demand or at least overcapacity relative to demand. This will also effect earnings unless productivity improvements take up the slack, which is an idea I find doubtful this late in the cycle.

The big puzzle in the report is the future optimism. The housing subprime contagion is spreading from subrime to Alt-A, and a slowdown in MEW (mortgage equity withdrawal) are all guaranteed to impact consumer spending at some point. Capital spending is dramatically slowing and the effects of that slowdown have not yet rippled through the economy. Finally, unemployment is a lagging indicator and is poised to head higher (I believe sharply higher).

Note the period lasting nearly two years starting in 2000 where the future index shot up far in advance as current activity was in contraction. It took another year after that for the future and current activity indexes to get in sync.

Judging from what we know about capital spending, the spreading contagion in housing, and recent upticks in initial unemployment claims, manufacturing optimism is simply unwarranted at this time.

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