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June 17, 2004

Manufacturing Taking the Lead?
by Chad Hudson

There were several economic reports released this week that showed the economy remained buoyant in May. In a departure from the recent past, there are indications that the manufacturing sector is more robust than the consumer sector.

Retailers reported that May retail sales showed strong year-over-year gains. The CSFB Retail Same-Store Sales Index increased 5.4%. Additionally, the latest International Council of Shopping Centers (ICSC) retail survey, which was formerly the Bank of Tokyo - Mitsubishi survey, showed that weekly same store sales index rose 5.3% from last year during the latest week. While this is usually a sign of strong retail sales, this shows a significant deceleration from earlier this year when the index was showing gains in excess of 7%. The 5.3% gain was actually the second slowest week since the first week of February. This raises further concern since the year ago period was weak with same store sales increasing less than 1%. The retail sales report from the Commerce Department does little to clarify the status of consumer spending.

The headline number from the Commerce Department is the month-over-month change. In May it increased 1.2% and 0.7% excluding auto sales. Because of holidays and other seasonal factors, these monthly results are seasonally adjusted to make the month to month comparison more meaningful. On a year-over-over year basis the increases were 8.9% and 9.8% respectively, both showing acceleration from April. Without seasonal adjustments, the year-over-year growth paints a much different picture. While sales growth is robust, excluding the seasonal factors, retail sales growth is starting to decelerate. The table below shows the difference between the two different data series for this year.

It would seem that by analyzing sales on a year-over-year basis, the seasonality would not be an issue. While 7.4% growth is strong, the deceleration in sales should be noted, especially in the current market environment where investors have bid up stocks in anticipation of continued economic strength.

Continued economic strength was evidenced in the latest Federal Reserve Beige Book. One notable exception was that high-end consumer electronics, appliances, and specialty and gift items were reported as soft in most districts. Auto sales were reported as mixed with some districts reporting a moderate increase while others reported flat to slightly down. Manufacturing was robust in all districts. Residential housing was strong in almost all the districts. Chicago did report some softness. The labor markets were strong in most districts. Only the Dallas district saw widespread weakness, while Richmond reported "soft labor demand in the retail sector" and Atlanta reported that "layoffs continued in the apparel and industrial chemicals sector."

Industrial production rose 1.1% in May, faster than the 0.7% increase economists expected. This was the biggest monthly increase since August 1998. On a year-over-year basis industrial production advanced 6.3%, which is the fastest increase since May 1998. Part of the reason the year-over-year change is so dramatic is that production fell 0.8% last year. Perhaps surprising is that industrial production in May eclipsed the previous high set in 2000.

For the past several months payrolls have been increasing and the latest Manpower employment survey reveals that it will likely continue in the third quarter. Manpower reported that according to its latest survey, 30% of employers anticipate hiring workers during the third quarter, with only 6% planning to reduce staff resulting in a 24% net employment outlook. This is the highest since the fourth quarter of 2000. After accounting for seasonal factors the employment outlook was unchanged from the previous quarter at 20%. Public administration was the only sector that didn't register a double-digit gain. Construction, Manufacturing, Mining, Service, and Wholesale & Retail Trade all had a 20% or better outlook.

Housing remains one of the strongest sectors in the economy, but is starting to show signs of leveling off. Housing starts dipped slightly in May to a 1.95 million annualized rate; however, building permits soared to 2.08 million, a new record. The National Association of Home Builders (NAHB) Housing Index fell 2 points to 67 in June. The largest decline was in buyer traffic, which dropped 3 points to 52. Current sales fell one point to 72 and sales expectations for six months fell two points to 73. Lennar and KB Homes reported second quarter results this week that were better than analysts expected. Lennar's net orders increased by 17%, and units in backlog grew by 24.4% and by 38.9% in dollar value. New orders increased the fastest in the West, 22%, and the Central market was the slowest, 11%. Interestingly, Lennar said it will be slowing sales via price increases because they cannot build houses as fast as contracts are being signed.

Mortgage applications rose for the week ending June 11. Both purchase applications and refinance applications increased from the prior week. It was the first increase in refinance applications since April 30, and only the second weekly gain since the second week of March. The percent of applications that are for adjustable rate mortgages increased ten basis points as it continues to hover around 35%. The dollar volume of ARMs is quite a bit higher at 47.5%.

Several companies updated guidance for the second quarter this week, with most increasing guidance. A few offer a glimpse of the status of the overall economy. Yellow Roadway, one of the largest trucking companies, announced that it will earn between 85 cents and 95 cents per share during the second quarter, well ahead of the 70 cents to 74 cents prior guidance. Nucor announced that it would earn about $2.75 to $2.95 per share during the second quarter. This is substantially above the $2.30 per share consensus estimate. Last year, Nucor earned just $0.11 per share during the second quarter last year and $1.43 during the previous quarter. Illinois Tool Works also raised its guidance for the second quarter. Earnings per share is now expected to be $1.14 to $1.18 per share compared to previous guidance of $1.04 and $1.12.

The University of Michigan Consumer Confidence survey jumped five points to 95.2, which was the first jump in three months. Economists expected a much smaller increase of 0.6 points. ABC Consumer Comfort Index fell one point to -20 continuing the decline the decline to four consecutive weeks. The personal finance component fell four points to 4, tying the lowest level ever reached for this component. The buying climate has been unchanged for two weeks at -32. This is the lowest level since the first quarter last year when the war was making headlines.

Last year, the economy was flooded with monetary and fiscal stimulus. These effects have started to anniversary. Plus, with the Fed poised to start raising rates the tailwind that has helped propel the economy forward will shift to a headwind. Economists expect the economy to be self-sustaining at this point and any economic deceleration caused by higher interest rates will be offset by higher employment. With consumer consumption comprising about 70% of the economy, if consumers are starting to wind down their spending, it will be difficult for the manufacturing sector to take up the slack.

Chad Hudson
Mid-Week Analysis
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