Industrial Numbers: Green Shoots Meet Late Frost

The Industrial Production (IP) and Capacity Utilization (CU) numbers released today do not support the idea that the economy is turning around. In March IP fell 1.5%, the same sized decrease it saw in February.

If the first quarter is taken as a whole, IP is dropping at an annualized rate of 20.0% -- that is the worst rate of decline seen for a quarter so far in this recession. IP is down 12.8% from a year ago, and is now at levels last seen in 1998. This is the worst year-over-year drop in IP since the Arsenal of Democracy was dismantled following WWII. (That was a good thing then, not so much now.)

If there is any way of looking at this report as a glass half full, it is that the monthly declines in December (-2.2%) and January (-2.1%) were greater than those for February and March. Manufacturing Production was hit even worse, falling 1.7% in March -- a much more severe decline than the 0.6% fall in February. Manufacturing output is down 15.0% year over year.

In the silver lining department, the November through March numbers were all revised up 0.1% each, making them slightly less negative than they had been. The worst monthly declines in manufacturing output were in December (-2.8%) and January (-2.7%), so perhaps it is possible to make the case that we are falling more slowly, but make no mistake, we are still falling and falling fast according to this report.

Mining production was hit even harder -- falling 3.2% in March, its worst drop this cycle -- and follows a 1.0% decline in February and a 1.3% decline in January. On a year-over-year basis it is down 6.9%. Utilities were the only bright spot, with production rising 1.8% following a 7.7% decline in February. That, however, appears to be mostly weather-related.

Turning to CU, things don’t look any better. The country is now operating at 69.3% of capacity. This is the lowest level since records of it started being kept in 1967. The history of CU is shown in the graph below (larger version available at http://www.calculatedriskblog.com/).

As the chart shows, 80% CU is about normal, and at least in recent years a reading of 85% represented boom times. It has occasionally dipped below 75% towards the end of nasty recessions. The only pullback in CU that was remotely comparable to this episode was the early 80’s downturn, although the slope of the decline was worse in the mid-70’s recession, it started from a much higher level. If 85% is a boom and 80% is normal and 75% is a severe recession -- what does under 70% mean? The term that springs to mind also has a medical context, and is often treated with Prozac.

With over 30% of capacity sitting idle, why would a company want to invest and expand capacity? This is very bad news for capital goods firms like Applied Materials (AMAT), Emerson Electric (EMR) and Illinois Tool Works (ITW). But it is also very bad news for corporate profits at manufacturing companies. Factories represent very large fixed costs, and if the factory is idle part of the time, the operating leverage works against you.

As the graph shows, CU is a coincident indicator, and one that has a very good track record of signaling the bottom of recessions. When it starts to turn up, then we can start to talk about economic recovery happening. That day still looks a ways off into the future.