U.S. Industrial Production Down By 0.5% In April - Wall Street Hiccups

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by: Tim Worstall
Summary

The Index of Industrial Production fell 0.5% in April, giving Wall Street a scare.

Industry is always the most variable of economic sectors so changes of this size are not abnormal.

We probably put too much weight on this statistical measure - industry's just not that important any more.

US industrial production was down by 0.5% in April reports the Federal Reserve. This caused a slight hiccup over on Wall Street:

The Dow Jones industrial average has dropped by 158 points in early trading to 25,373, a drop of 0.6%.

That wipes out much of Tuesday's recovery, sending the index back towards Monday's trade war-triggered lows.

Industrial stocks are leading the selloff, following the surprise 0.5% drop in factory output last month.

There are two major reasons why this isn't quite as alarming as it seems. Which is also why as soon as the auto tariffs were delayed the market went right back up again.

The first reason is in the details of the numbers themselves. Industry is, essentially, manufacturing plus energy plus construction. Mining is in there too but that's very much a holdover from the past, of which more in a little.

The problem with this is that not all of those are the same. Sure, more energy being produced is indeed more economic activity. But most energy is only produced when demanded these days, meaning that it's an input into the rest of the economy. Manufacturing on the other hand is still an output. Inputs and outputs aren't those same thing. We think it's a good idea if we economize on inputs as long as output stays the same. Or, we're able to make more from the same inputs of course.

So, if we're able to make more while using less energy we think this makes us richer. Yet here our statistic is assuming that generating more energy is a good thing. Which it isn't, quite, is it? And this is part of the explanation of these current numbers:

us industrial production About which the Fed says:

The output of utilities fell 3.5 percent in April, with declines in the indexes for both natural gas and electric utilities; demand for heating decreased last month because of temperatures that were warmer than normal.

Warm weather is hardly harmful for us. Imagine the opposite - it's freezing, so we produce more energy to keep warm, this makes us richer, having to do this?

True, other parts of the index also declined. There is this point of interest in the larger sense:

At 109.2 percent of its 2012 average, total industrial production was 0.9 percent higher in April than it was a year earlier.

If American industrial output is 10% higher than it was 7 years ago, then so much for the gutting of American industry, eh? It also being true that, by a slightly different measure, American industrial output is very close to the highest it has ever been. Vastly higher than in the 1970s and 1980s. But that's a political point really.

Industrial output is much more variable that that of the rest of the economy. Meaning that while we can take this index as an interesting pointer we can't simply extrapolate out to the rest of GDP. Manufacturing, for example, always slumps more in a recession than do services. And it's also true that bouncing around as here isn't unusual.

But the much larger point is that for historic reasons we generally, as a culture and even on Wall Street, pay too much attention to manufacturing. Despite what various people try to tell us there's nothing special about it. It's just another way of creating value that can be consumed. And we really do pay too much attention to it.

For example, a wide definition of the finance industry - including all insurances, pensions, savings, banks, etc. - would be about the same share of GDP as manufacturing. Health care would be a larger portion. Yet we don't gawp at monthly production figures for either of those two industries. The reason we do for manufacturing is that way back it was much more important, up at 40 and 50% of the entire economy. Now it's down in the 11 and 12% range - as I say smaller than health care, around the same as finance.

The reason we all look at this industrial output index is purely historic. If we were designing, newly, our economic statistics today we'd possibly not bother to pull the sector out as we do.

Which is a lesson for us as investors. Specific measures of industrial production can be useful if we want to talk specifically about industrial stocks. But they're a very poor guide indeed to the larger economy. Simply because they're too small a portion of that wider economy to influence it much. Take this 0.5% fall in industrial production. That's - a wrong estimate but a usefully sized one - a 0.05% decline in GDP. And we don't measure GDP to that small a margin, only to 0.1%.

If we're looking at the macroeconomy we should only consider industrial statistics to the extent that other investors believe them. For they really don't tell us all that much about an economy which is near 80% services and only a little over 10% industry.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.