Durable Goods: Another Straw For The Camel
In the ongoing series of economic reports released as of late which have missed consensus estimates - the durable goods report was the latest straw to be piled onto the "camel's back" showing softness in the economy. Of course, this really isn't surprising given the earnings news as of late from Caterpillar, IBM and even Apple.
After surging in February durable goods plummeted in March and this time it was not just aircraft related - the core rate contracted as well with both measures disappointing the consensus analyst estimates. New factory orders for durables declined 5.7% in March which fully reversed the 4.3% in February which followed a 3.75% drop in January. Not surprisingly, the always optimistic analyst community was expecting a decrease of only 2.8%.
If we break down the report we see that transportation declined 15.0%. Nondefense aircraft orders fell 48.2% and defense aircraft declined 11.4%. Automobiles, thanks to continued subprime auto loans and cheap financing, hung in there with a 0.2% increase.
If we exclude transportation (aircraft and automobiles) then durable goods orders decreased 1.4% following a 1.7% drop in February. Again, analysts were overly optimistic expecting a boost of 0.5% in orders excluding transportation. The bad news is that there was weakness in all major industries with primary metals down 3.0%; fabricated metals dropping 1.5%; machinery falling by 1.4%; electrical equipment sliding 2.4%; and "other" durables falling 1.0%. This news does not bode well for strength in the economy in the months ahead as these are the primary components of construction, manufacturing and production. Falling demand for metals, machinery and electrical equipment is not a sign of strengthening demand on businesses. Of course, this is why we have seen much weakness in the recent manufacturing surveys for both current and future outlooks.
The first chart below shows the annual changes in durable goods versus non-defense capital goods. Historically, when non-defense capital goods has fallen below 0% annual growth the economy has been close to a recession. However, notice that in 2007, non-defense capital goods actually strengthened as the economy headed into recession. This was due to the mortgage extraction from homes and easy credit cycle at that time. The question now, with the Fed's QE programs and low interest rate environment, is whether, or not, we are witnessing the same thing once again.
In the latest report the non-defense capital goods orders excluding aircraft were basically flat, rising just 0.2%, after falling 4.8% in February. The chart below shows the 3-month average of the annual rate of change in both durable goods and non-defense capital goods (core-capex). By smoothing the annual data with a 3-month average we can more clearly see the negative trend in the data.
As I have been discussing in recent weeks it is clear that the economic rebound from the last recession ended in 2011. For mainstream analysts, and economists, the latest report on durable goods orders was unexpectedly weak in March and softness was widespread. However, the recent weakness should come as little surprise for those that have actually been paying attention.
The importance for investors is that eventually enough straws will "break the camel's back." It is always just a function of the economic cycle regardless of the amount of stimulus being thrown at it. Recessions and corrections are both ways in which the cycles clear excesses that have been accumulated over time. While stimulus programs can artificially inflate asset prices and extend business cycles temporarily - eventually those excesses will be corrected regardless. The only difference is that, as we saw in 2008, when an artificially inflated asset market comes to grips with a deteriorating economic cycle - that is when the "oh...****" moment occurs.