This is the 11th in an occasional series showing how major economic reports can affect the stock and bond markets
The U.S. economy is sailing through rough waters right now, and one sector, manufacturing, has already washed up on the rocks. Will the factory recession get so severe that it drags down the whole economy--which will further hammer profit expectations and stock prices?
To find out, investors have to pay attention to the manufacturing numbers. "Manufacturing is the most cyclically sensitive sector," says Suzanne Rizzo, U.S. economist at New York consulting firm MFR. "When you are looking for a turn in the business cycle, you can get an advance read from the factory data." For instance, because of an overbuilding of inventories, the manufacturing sector cut production and employment in earnest back in the early fall of 2000. The rest of the economy didn't show signs of slowing down until a few months later, around the time the stock market got a whole lot worse.
In addition, though manufacturing accounts for just 16% of the economy, its influence is felt across a spectrum of industries, such as advertising, computer services, consulting, and retailing. So even if your holdings don't include any smokestack companies, you still need to know whether factories are busy or not.
You can gain some insight through four monthly reports. One is the Federal Reserve's Industrial Production & Capacity Utilization report. The U.S. Commerce Dept.'s Bureau of the Census puts out two: the Advance Report on Durable Goods Orders and the report on Manufacturers' Shipments, Inventories, and Orders. Lastly, the National Association of Purchasing Management calculates the monthly purchasing managers' index for manufacturing (BW--June 5, 2000), known to be a favorite of Fed Chairman Alan Greenspan.
Savvy investing, of course, is about anticipating the future. That's one reason why "durable-goods orders is the most closely watched" of the government reports, says Rizzo. If the makers of durable goods see increased demand for their products, future production and revenues look good. As its name implies, the report covers the dollar value of new orders for durable goods, typically defined as goods that last more than three years. Since most hard goods are expensive and financed on credit, the sector is very sensitive to swings in interest rates. Thus, a change in Fed policy affects this sector first--another reason Wall Street pays close attention.
The durable-goods report sums up the demand for many items from high-cost aircraft to low-tech office furniture, so you have to get behind the summary numbers to understand what's going on. (The data can be found at www.census.gov.) For instance, on Feb. 27, Commerce reported that orders plunged 6%, and Wall Street took that as a sign that the economy was going to hell in a handbasket. Investors clamored for an immediate Fed rate cut. But if you stripped away a huge drop in airplane orders, durable goods fell a less worrisome 1.6%. No wonder the Fed waited until its scheduled Mar. 20 meeting to cut rates.
In fact, when some Fed officials want to see how business spending on capital goods is holding up, they focus on new orders for capital goods excluding defense and aircraft. If you're buying shares in companies making heavy machinery or tech hardware, that's the order category to watch. Look for the March report on Apr. 25.
The shipment and inventory report, also called M-3, covers durable and nondurable goods. It comes out about a week after the durable-goods news and is available at the same Web site. Typically, Wall Street pays less attention since the durables report contains the bulk of the orders data. What's new is a first look at inventories. In an economy veering toward services, activity inside the nation's warehouses is usually pretty boring stuff. But nowadays, inventory news is hot because our current sluggishness can be traced to a buildup of too many goods. As Greenspan told Congress on Feb. 28: "A round of inventory rebalancing appears to be in progress. Accordingly, the slowdown in the economy that began around the middle of 2000 intensified, perhaps even to the point of growth stalling out around the turn of the year."
TOO BIG A GAP. What went wrong? In 2000, business kept stocking merchandise even as demand slowed in response to the Fed's prior interest rate hikes. By September, the M-3 report showed that inventories were building while sales fell. In response, factories, especially auto makers, cut output and jobs. Rizzo says the magnitude of the inventory overhang "can mean the difference between soft landing and recession." That's because if manufacturing's woes spread, the resulting layoffs and loss of income can stop consumer spending in its tracks.
What's Greenspan looking at to gauge factory activity? The Fed has its own factory numbers: the industrial production report. The total industrial production index is made up of indexes covering manufacturing, mining, and utilities. The latest data show factory production falling for five consecutive months. Check www.federalreserve.gov on Apr. 17 to find its March performance.
The report also contains capacity-utilization rates, or how much of their physical plant and equipment factories are using. An average operating rate over 85% can signal that the economy is growing at such a robust pace that production shortages or bottlenecks threaten big price increases. That was a chief concern of the Fed back in 1994 when it last brought the economy in for a soft landing.
Remember the soft landing? That's what the Fed was aiming for with its 1999 and 2000 rate hikes. But business slowed too much, and now the Fed is fighting the risk of recession. Can it put the economy back on track? Manufacturing will tell. But you don't have to punch a time card or wear a hard hat to see what's happening on the factory floor. The manufacturing numbers tell all.
By Kathleen Madigan