This week's economic data flow for the industrial sector offered a conflicting message. What I've learned as a fisherman is that where there are choppy seas there is change. Either the wind is blowing in the opposite direction of the tide or one current is bashing up against another. What matters is that one of the two forces will eventually win, and in this case, I believe it will be the force for change, and for the worse.
The article I authored entitled More Manufacturing Malaise was published the same morning that the trading pit celebrated the positive surprise in the ISM Manufacturing Report. I thought, oh boy, the comments are going to be harsh today. But fear not, because just a day later, with the arrival of another data point, the market is once again in the red with the latest complaints lost to the wind. Of course, the disappointing ADP Private Employment Report contributed significantly to the darkness of the day generally, with the SPDR Dow Jones Industrial Average (NYSEARCA:DIA) down about 0.4% through morning before taking back some ground.
Factory Orders were reported Wednesday morning for the month of March. It seems the forewarning from the prior week's Durable Goods Orders data was forgotten. Durable orders fell 4.0% in March (revised this week from -4.2%), and even when excluding high-ticket transportation goods, durables orders still dropped 1.1%. March Factory Orders fell 1.5%, contrasting sharply to February's revised increase of 1.1%. However, economists, with the forewarning, had forecast a decline of 1.6% at the consensus.
Let's look at the one key conflict offering strong support for manufacturing. ISM's Manufacturing Index was reported up to 54.8% in April, from 53.4% in March. The first thing to note is that ISM is measuring a different month (current though) than the factory orders data, but the regional indexes reported by the Federal Reserve Banks have also measured April and have offered conflicting information as well.
The market was enthused Tuesday to see New Orders and Production up, with the two component indexes important for the overall PMI rise. Employment also increased, but we note yet again that this is a lagging indicator for the economy and for segments within it. Contrary to my greatest concern, ISM reported that exports were higher in April, with its export component index up 5 points to 59.0. I expect this was an important cog for the market's drive higher. However, I continue to foresee issue within the important European market, where 20% of America's exports are sold into. Also, the effects of European and U.S. economic slowing weigh on the emerging world that supplies it. As the situation is yet developing (Spain only just fell into recession), I expect this measure will deteriorate in the future. Also important to note, prices are on the rise; depending on the reason, this can be a positive or a negative reflection of/for the economy. Of the many commodities measured, only two saw price decline, including natural gas and steel. Finally, qualitative comments taken from survey respondents seem to show mixed business sentiment, though 16 of 18 manufacturing industry respondents reported growth to ISM. It is important to note that the index is really a measure of sentiment, where factory orders data is a direct reflection of activity.
Returning to the disappointing Factory Orders data, New Orders were lower by 1.5%, mainly due to durable goods orders, especially in transportation equipment. Durables orders fell 4%, while transportation equipment orders dropped 12.6%. In fact, when excluding transportation, orders were flat overall. Because of the high-ticket nature of transportation equipment, this figure varies greatly and is therefore screened out to allow for a clearer view of general economic activity. However, one could argue that transportation equipment will lead economic trends, given its long lead time to delivery. Purchasing managers in this segment would tend to act more conservatively due to intensified risk. On the positive side of things, non-durable goods orders increased 0.5% in March.
Not alarming, but worth keeping an eye on, inventories are up to their highest level on record. This is of course expected in a growing global marketplace. However, it also makes the monitoring of unfilled order trends that much more important. Those continued to rise, but not at an alarming rate.
Something may be developing in transportation equipment though, given the important increase in the segment inventories at the same time that new orders are declining sharply. Aircraft might be of highest concern, given its closeness to consumer spending and the fact that non-defense aircraft and parts orders declined 47.6% in March. Also, orders for ships and boats were down 8.4%. The order to delivery timeline for these products and the trend noted here might provide some concern for the manufacturers' shares, including Boeing (NYSE:BA), Trinity Industries (NYSE:TRN), American Railcar Industries (NASDAQ:ARII), Greenbrier Cos. (NYSE:GBX), Navistar (NYSE:NAV) and PACCAR (NASDAQ:PCAR).
In conclusion, one final important point needs to be repeated. New orders of non-defense capital goods excluding transportation declined 0.8% in March. While this followed a 2.8% increase in February, that gain also followed a 3.4% decline in January. This segment is what economists follow most closely for a view to business spending. Also, nondurable goods orders continued to rise. Until these segments soften, the economy should not reside in recession, though the stock market will lead not follow. Early indicators of trouble do exist in my view with regard to durable good order trends and within the transportation segment. Manufacturing continues to be supported by development of the global marketplace and the middle class overseas, but it should neither be immune to the spread of contagion from the important European market nor new issue in the critical U.S. market. The American market remains vulnerable, due to a still hobbled labor situation and the new paradigm defining capital availability in the States post the financial crisis. We'll continue to keep close inspection of the industrial sector so as not to wind up lost in its choppy seas.