Industrial Production And The Recovery
This morning's release of industrial production and capacity utilization numbers sparked some early interest in the markets as the index perked up in April. Utilities played a key role along with a bump in manufacturing pushing the industrial production index higher by 1.1 percent. The rise offset the sharp decline of 0.6 percent in March, however, excluding motor vehicles, which are still be shoved onto dealer lots, the manufacturing component only gained back half of the 0.6 percent decline last month. Capacity utilization improved to 79.2 percent from 78.4 percent in March. This isn't necessarily all good news.
As we have discussed many times previously in our various reports the abnormally warm winter suppressed the needs to utilize utilities giving consumers a needed $30 billion tax credit. However, the return to normal weather related trends led to a jump in utilities output of 4.5 percent in April. Look for an impact in the coming months to consumption as we should see a marked increase in the amount of money being diverted to cover utility bills versus buying new iPads. While paying for utilities is technically spending - it just doesn't go a long way to drive the consumptive demand that companies need to increase employment.
The first chart shows the year-over-year change in capacity utilization and industrial production. While industrial production and capacity utilization have recovered from the recessionary lows they have recently peaked at levels normally consistent with a peak of economic recovery. This is no small point. While the Federal Reserve may be able to extend the business cycle to some degree due to various interventions - they have not figured out a way to repeal it. We have been discussing recently that it is highly likely that we will continue to see deterioration in the economic numbers over the next few months as the support from "Operation Twist" and the Long Term Refinancing Operations in Europe come to an end.
I reached out to my friend Doug Short today and asked him about inflation adjusting industrial production so we can see the impact caused by the shift from a primarily manufacturing and production based economy to one based primarily on finance and services. The first thing to notice is that industrial production (blue line - left scale) has not yet surpassed the previous peak more than 3 years after the last recession. This has never been the case before. However, that is on a nominal basis. When industrial production is adjusted for inflation (red line - right scale) it is a vastly different picture. As Doug pointed out this is a bit difficult to grasp and suggested utilizing a compounded growth based on both CPI and PPI.
Industrial production based on a compounded growth rate has risen by more than 600% since the inception of the index. However, even utilizing this metric you can note that industrial production has failed to recover since the end of the last recession. This is a testament to just how weak this recovery has been even when considering the trillions of dollars injected into the economy through various monetary and fiscal interventions. However, on a inflation adjusted basis "real" industrial production has declined by more than 33% and has only modestly increased from its historic lows.
However, Doug also suggested adjusted nominal industrial production with PPI as a measure of inflation which would be more representative of production rather than CPI which is a measure of consumption based inflation. What we find is that when industrial production is adjusted by PPI the rate of decline shrinks to only a bit more than 14%. This is obviously better - but not by much.
When utilizing either measure to adjust the index for inflationary pressures it is clear that industrial production is lagging during the current recovery. The sub-par growth rate of the economy has created tremendous slack in the overall environment and businesses are still remaining extremely cautious and protecting their bottom lines. The economic weakness that prevails is curtailing increases in hiring and capital expenditures unless absolutely needed. This continues to leave a large and available labor pool which continues to suppress wages and companies are opting to hire more on a temporary than a full-time basis.
The issue that we are watching, as shown in the recent Empire Manufacturing Index report, are the future expectations by manufacturers which have begun to deteriorate as troubles continue to brew in the Eurozone and weakness shows up in the domestic economy. Remember economic reports are lagging by one to three months so it is important to view the reports with a bit of skepticism when making forward projections.