Industrials - Weak January Industrial Production

The two most important hard data reports of the past few weeks were the December retail sales report and the January industrial production report. They were both bad. 

A dovish Fed can’t stop stocks from falling in my opinion because the economy is still weak and earnings growth is still very low. I’m only saying this because stocks are overbought. There’s something in between a bear market and one of the strongest snapback rallies ever.

As you can see from the chart below, monthly industrial production fell 0.6% which missed estimates for 0.1% growth. It was below the lowest estimate for -0.3% growth. 

The December reading was revised from 0.3% growth to 0.1%. Keep in mind, it’s foolish to say industrial production is falling because it’s still up 3.8% year over year. Growth recently peaked at 5.7% in September. Industrial production bottomed at -4% growth in December 2015. 

Industrials - Still much room to fall before the previous cycle trough is met, meaning we are far from a recession.

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Manufacturing was down 0.9% month over month which sharply missed estimates for 0.1% growth. The lowest estimate was -0.5%. The December reading was revised from 1.1% to 0.8%. 

Capacity to utilization still had plenty of runway in December even though it was revised 0.1% higher to 78.8%. Now it has much more room as it fell to 78.2%. The consensus was for 78.8% and the low end of the range was 78.5%.

Vehicle production was down 8.8% monthly after rising 4.3% in the previous month. Business equipment was down 1.5% after rising by 0.9%. Utilities were up 0.4% and mining was up 0.1%. Mining volumes were up 15.3% yearly and manufacturing volume growth was 2.9%. 

Manufacturing growth doesn’t include price inflation. Including it gets growth to the mid single digits. In summary, this report was bad. But not bad enough to suggest a recession is coming soon as year over year growth only fell from 4.1% to 3.8%.

Industrials - Effect On Industrial Stocks

The chart below shows the overall trend in the market has been magnified by the industrials. 

This sector underperformed the S&P 500 in Q4 last year while economic data weakened. Now it is sharply outperforming while most reports show there is still a weakness. This chart uses the ISM, but the industrial production and February Philly Fed readings were weak. 

Relative strength in the industrials sector went from about -10% in December to -6% in mid-February. Meaning it outperformed the S&P 500 by 6%. No sector has been hotter in the past few weeks. Boeing stock is up 29% year to date. 

The industrials sector’s advance decline line has beaten its September peak. While the S&P 500’s advanced decline line is still below its September high.

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Industrials - Terrible Philly Fed Index

February Philly Fed manufacturing index was a disaster as it was -4.1 as the chart below shows. 

This fell from 17 last month which missed the consensus for 14 and was way below the lowest estimate which was 12. This weakness differs sharply from the Empire Fed report I will review next. 

Philly Fed new orders index fell from 21.3 to -2.4. Shipments index fell from 11.4 to -5.3. Even though the current index crashed, the 6-month expectations index was steady as it went from 31.2 to 31.3. 

New orders index fell slightly from 32.2 to 29.4. Expected shipments rose from 36.2 to 39.8. Capex index was up from 31.6 to 31.7. Usually, these regional Fed manufacturing surveys are volatile, so it’s unusual to see almost no change.  

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Let’s quickly review the special questions from the Philly Fed report. These questions were mostly about expectations for the next year. 

Prices received are expected to increase by 2.9% and prices paid for employee wages and benefits are expected to increase by 3%. The prices received estimate fell 0.1% from November and the prices paid for workers was the same. 

Industrials - Inflation estimates have been falling 

Inflation has been weak in the past couple of months. I’m very interested to see the January PCE inflation reading which will come out on March 1st.

Continuing the theme of less inflation, the prices employees are expected to pay for goods and services fell from 2.5% growth to 2.5%. Prices U.S. consumers are expected to pay fell the quickest as the price growth consensus fell from 3% to 2.3%. 

The average estimate for consumer price growth over the next 10 years fell from 3% to 2.5%. That low inflation would be fantastic for the economy.

Industrials - February Empire Fed Index Beats Estimates

The best estimate for the ISM manufacturing PMI is the average of all the regional Fed indexes. The current average is the middle of the Empire Fed. And Philly Fed index as of now because only two have come out. 

The average is weak since the Empire Fed index showed moderate strength and the Philly Fed index showed sharp weakness.

Empire Fed index was 8.8 which beat the consensus for 7.6 and the prior reading which was 3.9. New orders index was up 4 points to 7.5. Shipments index fell 7.5 points to 10.4. 6-month forward-looking index was much stronger as the general business conditions index was up from 17.8 to 32.3. 

New orders were up 16.2 points to 35.7. Shipments were up 12.7 points to 35.1. Finally, technology spending and capex were up 2.1 and 11.4 points to 22.1 and 29.3. 

Overall, this report was ok with much of the strength in the 6-month forward index. We will get a better picture of the manufacturing sector when the other regional Fed indexes come out. But I lean bearish since yearly industrial production growth has been falling since it peaked in September.

Industrials - Conclusion

It’s not surprising manufacturing is slowing because it is more internationally focused than services. This differs from the Markit PMI report from January. I expect manufacturing to weaken further in the next few months until Europe and China turn around. 

A trade deal would help the situation.