By Dirk van Dijk, CFA
New Orders for Durable Goods fell 3.3% in October. That was much worse than the consensus expectations for a decline of 0.3%.
The bad news cannot just be pegged on the extremely volatile Transportation Equipment side, and more specifically, from the Non-Defense Aircraft component, which is often the case when we get a bad headline durable goods number. That is mostly orders for big 777’s and 747’s from Boeing (BA), which are very expensive items. It also includes orders for business jets from firms like Textron (TXT). A few orders for new jumbo jets can really skew the numbers for the month.
This month the weakness was very widespread, with every category recording declines except for miscellaneous durable goods, a relatively small category that accounted for just 16.9% of all new orders in October. Excluding transportation equipment, new orders fell 2.7%, well above expectations for a 0.6% increase. Overall transportation equipment orders were down 5.2%, and more specifically, non-defense aircraft orders dropped 4.4%.
If one want to gauge how much demand for long-lasting goods is coming from the private sector, then one needs to strip out orders from the Pentagon. Excluding defense, orders for capital goods were down 2.1% in October, after rising 4.5% in September.
A Silver Lining
While this month's numbers are extremely disappointing, there is a silver lining. Last month’s numbers were revised sharply higher. Total new orders had been thought to have risen by 3.5% in September, but that was revised to a rise of 5.0%. Orders ex-transportation equipment were actually up 1.3% in September rather than down 0.4%, as had been previously reported.
Even if one strips out the most volatile sectors, like transportation equipment, durable goods orders can move around a lot from month to month. It is worth taking a step back and look at the longer-term picture. If you look at total new orders so far in 2010 relative to the total new orders in the first ten months of 2009, things still look pretty good. Total new orders year-to-date are running 14.7% higher than last year, and if transportation equipment is stripped out, orders are up 13.9%.
Excluding defense, year to date orders are up 15.6%. In other words, we had a very robust recovery in orders early in the year, but that momentum is fading. It is important to keep in mind just how weak the economy was in the first ten months of 2009. The year-to-date gains say as much about the conditions last year as they do about current conditions. It would be a big mistake to think that the year-to-date numbers represented some sort of normal growth rate.
Core Capital Goods
One of the areas that this is most apparent in is in what is known as “core capital goods.” Those are orders for non-defense capital goods, excluding aircraft. That is a very good proxy for what businesses are investing in equipment and software. That investment is a direct input into the GDP growth calculations, and one of the real bright spots for the economy in the first half of the year.
That is the sort of spending that is a bet on the economic future of the country, and is also one of the areas that trends to swing with overall economic conditions. Those swings are a big factor in determining if the economy is growing or shrinking.
On that front, the news in October was a turn for the worse from September, as core capital goods orders fell by 4.5%, versus an increase of 1.9% in September, and a 5.1% rise in August. Year-to-date looks pretty good, with orders running 16.8% above last year’s pace.
Some of the areas that had the biggest declines this month were ones that were strong in September and August. Orders for computers and related equipment fell by 7.7%, more than reversing a 2.0% rise in September and a 3.9% rise in August. Year-to-date orders are up 11.9%. There seems to be something to the downbeat guidance that Cisco (CSCO) gave on its conference call.
Results by Industry
The Machinery industry saw new orders fall by 3.9%, a reversal of the 3.5% rise in September and a 5.4% rise in August. Year to date, though, things are not so bleak in the metal-bending world, with orders up 20.9%.
There orders were down 0.7% on the month, after declines of 0.3% in September and 5.1% in August. Don’t cry too much for Detroit (well at least the auto industry there; the city itself is another story), as year to date, motor vehicle orders are up 11.9%.
Non-Defense Aircraft orders were down 4.4%, but that comes on the heels of a 112.6% rise in September but after a 30% plunge in August. I told you it was a volatile group. Year to date, though, orders are more than double the 2009 year to date total, up 105.2%.
Orders for defense aircraft also tend to be lumpy, and fell 25.1% after rising 29.7% in September. Year to date, though, orders for Navy and Air Force aircraft are up a relatively subdued 3.4%.
An Ugly Report
Overall this was an ugly report. Not only was the headline number weak, but the declines were very widespread, and far below expectations. The upward revision to the September numbers takes just a little bit of the edge off of the bad news, but does not come close to totally offsetting it.
With the stimulus wearing off and state and local government forced to cut spending sharply (or raise taxes) to balance their budgets the economy there is not a lot of fuel to spark a robust recovery. Consumers are still trying to deleverage their balance sheets by paying down debt and building up their savings. After trillions upon trillions of their wealth vaporized in the collapse of the housing market they have no choice but to do so.
Housing construction, is normally a major positive force in pulling us out of recessions, but is totally missing in action this time around. While the year-to-date numbers still look great, that is not going to last if we keep reporting monthly numbers like this. The widespread nature of the declines is particularly disturbing.
Businesses still have plenty of excess capacity so the only reason to invest is in areas that cut costs, not in areas that expand capacity. Cutting costs usually means substituting capital for labor. That helps raise productivity, but is not particularly helpful in reducing unemployment. Very low interest rates do help spur investment, but regardless of how little it costs to borrow, no business is going to want to invest in capacity that is just going to sit idle from lack of demand.
More Stimulus Needed
In such an environment we need more fiscal stimulus from the government. Crowding out of the private sector is not an issue right now. That only happens when the government has to compete with the private sector for real resources, like qualified employees. Right now the government would not be competing with the private sector, but with idleness and unemployment.
It is downright stupid not to take on the competition, especially when it costs the government so little to borrow long term. Talk about sharply cutting federal spending, especially for the social safety net is not just cruel, it would be exceptionally bad economics.
If defense and the popular entitlement programs for seniors and veterans are off the table, balancing the budget through spending cuts would require the shut down of the entire rest of the Federal government. Thus anyone who suggests that we could keep the high-end tax cuts, and balance the budget through cutting spending a) has never looked at the Federal Budget and has no idea what the money is spent on, or b) is deliberately misleading you, or c) advocating getting rid of the FDA, the SEC, the court system, the national parks, the Department of Justice, the federal prison system, the FBI, all spending on highways, food stamps, crop subsidies, Pell grants and the EPA. I would put my money on option B.
Disclosure: No position