APICS Business Outlook Index

Manufacturing Activity Falls Sharply

By Michael K. Evans

The APICS Business Outlook Index fell sharply in November, plunging to 44.8 from 49.5. Most of the decline occurred in the Current Component Index, which fell to 41.3 from 48.1. The Future Component Index declined to 48.3 from 51.0.

The results indicate that manufacturing firms intensified their effort to reduce inventory stocks in November. Thus while shipments continued to rise, the survey results show unusually low figures for employment, production and inventories.

These figures do not suggest the economy is heading into an actual downturn. New orders declined slightly, but not enough to indicate recessionary conditions ahead. Furthermore, most firms indicated that after the current round of inventory correction had been completed, production plans should improve at the beginning of next year. Finally, firms continue to report that the ratio of the actual to desired inventory/sales (I/S) ratio is declining, although stocks have still not been trimmed quite enough.

The latest survey results thus suggest that manufacturing activity will be sharply depressed in November and December, but will then rebound starting in January.

Current Conditions Component

Manufacturing Shipments continued to rise in November, even though production declined. For the past three months, shipments have risen about 0.6 percent, reflecting the desire of firms to reduce inventory stocks.

Manufacturing Employment fell an estimated 50,000 in November, compared to a 21,000 drop reported by the Bureau of Labor Statistics (BLS) in October; our survey results had shown a 30,000 decline.

In the September APICS survey, the results for Manufacturing Production showed an increase to 58.5, which we interpreted as a 0.6 percent rise in production. The preliminary figures showed only a 0.2 percent gain; however, when the revisions were issued a month later, that figure had been revised to 0.5 percent. Similarly, the APICS survey showed a big increase in manufacturing inventory stocks, which also turned out to be the case. Apparently, firms decided to build inventory stocks in September instead of reducing them. Perhaps they expected a pickup in demand.

That pattern was reversed in November. According to the survey results, manufacturing production fell at least 0.3 percent for the month, and possibly as much as 0.5 percent. The supporting data indicate that the reduction was caused primarily by an attempt to reduce stocks.

Manufacturing Inventory Stocks fell in November, declining about 0.2 percent. Since the government figures are in current dollars, the volume of stocks probably declined even more rapidly.

Future Conditions Component

New Orders for durable goods, excluding transportation, fell about 0.8 percent in November, according to the survey results. That is a modest decline, and suggests that new orders held up fairly well in view of the sharp decline in production and inventory stocks. According to the APICS survey, most of the decline in new orders occurred earlier and have essentially been flat since June.

The combination of the continued gain in shipments and slight decline in new orders points to about a 0.5 percent reduction in Unfilled Orders.

The Production Planning series has fluctuated widely during the year, but those changes have accurately indicated what was about to happen. The index fell sharply in February; actual production then plunged in April. The planning index then reversed course in June; actual production picked up in August. It then fell again in September, and production is expected to be down in November. Now that the index has risen again this month, production should rise starting in January.

A year ago, about 44 percent of the survey participants indicated that their actual inventories were above desired levels; the remainder said they were at or below desired levels. This month, 63 percent of the firms report that their inventories are above desired levels.

This series has to be adjusted in the sense that a "50 percent" reading does not mean inventories are in balance. Some firms report that the actual I/S ratio is still above desired levels even when data taken from the rest of the survey indicates that stocks are in balance. In other words, their "desired" goal is generally out of reach. Seen in that light, the 44 percent reading a year ago was an exceptionally low figure and indicated that firms would be boosting stocks in early 1995, which is indeed what occurred.

Taking this bias into consideration, the data suggest that the current level of stocks relative to sales should provide a slight boost to production early next year, since the inventory correction has almost run its course.

1995 will end on a sour note, but economy will recover
The economy is clearly not very strong at the moment. Discretionary consumer spending, housing, capital goods excluding high-tech equipment, net exports, and government purchases are all flat. The only current strength in final sales is the fairly steady rise in consumption of services, plus continuing gains in purchases of high-tech equipment. Those two components together account for about a 1.5 percent growth rate in total real gross domestic product (GDP).

That figure does not include any changes in inventory investment. In the third quarter, according to the Bureau of Economic Analysis (BEA), constant-dollar inventory investment rose slightly. Thus a sharp decline in inventory investment this quarter and next seems to be the most likely alternative, which could reduce the growth rate to 1 percent or less this quarter and next. These estimates are more tentative than usual because BEA is switching to a new system of deflating the current dollar figures.

Thus the underlying data clearly point to a slowdown in final sales to about 1.5 percent, plus some further near-term weakness because of inventory decumulation this quarter and next. For the remainder of 1996, the following alternative scenarios could occur:

As soon as the inventory reduction has been completed, real growth returns to the 1.5 percent range, the same as the gain in final sales.
The "unexpected" declines in production and employment cause firms to revise their expectations downward, leading to a recession later in the year.
Same as (2), except that once growth approaches the zero mark, the Fed cuts interest rates enough that real growth rebounds to 2 to 3 percent in the second half of 1996.

Based on the latest APICS survey results, the most likely outcome is number one. However, there are also some elements of number three in our forecast, which means we expect a modest rebound in growth to about 2 percent later in 1996 because of some modest Fed easing. Along those lines, scenario two can be almost completely ruled out.

Although the 4.2 percent real growth rate for the third quarter was roundly denounced as nonsensical, the Fed has a great deal of difficulty easing when the government claims real GDP is rising at above-average rates, and in addition, the unemployment rate is only 5.5 percent, which most economists consider to be full employment. On the other hand, if real growth falls to 1 percent this quarter, and if the unemployment rate starts to rise, the Fed would presumably have no trouble deciding to ease in early 1996.

The latest APICS survey thus suggests that the economy will be quite weak for the next two months, resulting in some further cuts in the Federal funds rate by early 1996. That reduction in rates, coupled with the end of the inventory decumulation, should boost real growth back to about 2 percent for the rest of the year.

Click here for a graph of APICS Index performance over the last 12 months.

Click here for a table of Current Component and Future Component data compiled over the last 12 months or click here if your Web browser is cable of viewing tables in html.

All opinions expressed in this report represent the viewpoints of Evans Economics, Inc., and are not necessarily those of APICS.

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