November 1996 € Volume 6 € Number 11

Humming Along, But Still Nervous

By Michael K. Evans

T he APICS Business Outlook Index rebounded in September, rising to 53.8 from 46.4. The Current Component rose to 53.6 from 45.4, while the Future Component moved up to 54.0 from 47.4.

Last month we pointed out that the August dip was only temporary, caused by a change in summer vacation schedules, and a recovery was likely in September. However, the September figures show more than a mere rebound, because the 53.8 value of the index is substantially higher than the 49.7 average of the past two months. Hence the pace of manufacturing activity has accelerated in September.

Based on the macroeconomic figures showing slumping retail sales in conjunction with still robust gains in production, we might have expected to see signs that inventory stocks were increasing to unwarranted levels. However, the September data do not contain any evidence of this development. Indeed, inventory stocks hardly increased at all this month and the inventory/sales ratio remains at satisfactory levels. Production plans call for further gains in the fourth quarter.

Apparently the economy was not hurt very much by the rise in interest rates during the first half. While retail sales are flat and housing is sluggish, the survey results suggest that capital spending and exports remain strong. Now that interest rates have retreated from their midyear highs, real growth should remain at average or better rates next year.

Nonetheless, the latest figures suggest continuing signs of nervousness. After increasing briefly in August, manufacturing employment slipped again in September and will probably head lower for the rest of the year. The buildup in order backlogs remains at very modest levels. Firms are apparently pleased about the recent gains in new orders but a bit skeptical about the durability of the recovery, ready to power down at the first signs of approaching weakness.

In a real sense, this heightened sensitivity to nuances of the business cycle is likely to prolong the boom since the excesses that often used to appear at business cycle peaks are now absent. Hence we see the expansion continuing indefinitely.


Current Conditions Component

• Manufacturing Shipments rebounded sharply in September, rising about 1 percent. In August, the APICS survey called for about a 0.5 percent decline in shipments; durable goods shipments rose a reported 0.3 percent, with nondurable goods shipments expected to decline significantly.
  
  
• Manufacturing Employment declined an estimated 10,000 to 15,000 in September. Last month, the survey indicated a 5,000 to 10,000 rise, but we also pointed out that because of different seasonals in the Bureau of Labor Statistics (BLS) data, that agency would report a gain of 30,000. The preliminary BLS August gain was indeed 25,000. Our main point here is that the August gains are not expected to be repeated in September; manufacturing employment is expected to return to its downward trend this month.
  
  
• Manufacturing Production is back on track, with an expected gain of 0.4 to 0.5 percent in September. Over the summer, the Fed index of production did not contain the same seasonal seesaw that appeared in other government data, so manufacturing production reportedly rose 0.3 percent in both July and August. In any case, the September gain is expected to be larger than the average of the previous two months.
  
  
• Manufacturing Inventory Stocks probably changed little in September; they probably rose 0.1 percent. The August inventory data are not available yet, but we estimate that inventories fell slightly last month. The APICS data clearly do not yet indicate any unwanted buildup in inventory stocks.

Future Conditions Component

• New Orders, excluding aircraft and defense, probably rebounded sharply in September. Last month, we predicted a 0.7 percent decline, which was in the right direction and larger than most others had expected, but was still dwarfed by the actual 3.1 percent drop for total durable goods new orders, and 1.6 percent, excluding transportation. The APICS figure bounced back to 56.9 for September, indicating a 1.5 to 2 percent gain in this category of new orders for September.
  
  
• Unfilled Orders probably did not change very much in September, as both shipments and new orders rebounded sharply this month. Firms are anxious to ship newly ordered goods as quickly as possible, and prefer not to build backlogs at this stage of the cycle.
  
  
• The index for Production Planning improved slightly in September, rising from 53.6 to 54.0. Thus firms are expected to boost production even further heading into the fourth quarter. In particular, they do not plan to implement the sort of shutdowns that dominated activity a year ago. For the last three months of 1995, manufacturing production was flat; by comparison, the latest survey results indicate it will rise by an average of 0.3 to 0.4 percent per month in the upcoming quarter.
  
  
• The ratio of the actual to desired level of the Inventory/Sales (I/S) ratio fell again in September, due in part to the gain in shipments. The actual number rose to 53.6; since this series enters in the index in an inverted form, the actual I/S ratio is just below desired levels. The difference is not large enough to suggest that inventory investment will increase over the next three months; but there is no indication that stocks have risen too rapidly, or that any near-term cutbacks are planned.

It just keeps on ticking
We are now in the 66th month of the current business cycle expansion. It is notable enough this is the third longest expansion on record (excluding World War II), but even more remarkable, nothing untoward has happened. In the 1961-69 expansion, there had already been a credit crunch by the 66th month; only increased spending on the Vietnam War postponed the recession for a while. In the 1982-1990 expansion, the stock market collapse had already occurred by the 66th month; only the opening of the credit floodgates kept that plunge from hurting the economy, an act that may have laid the groundwork for the rise in inflation during 1988-89 that eventually led to the 1990 recession. But at least so far, we are enjoying what has been called the "Goldilocks economy."

There has never been a business cycle that died of "old age." Years ago, some economists used to believe that after consumers had bought "everything," and businesses had purchased all the capital goods they needed, the economy would head into a slump. Today we know that business cycle expansions come to an end only when the following imbalances occur:

1. Demand outstrips supply in both product and factor markets, causing wages and prices to rise at an accelerating rate. That leads to a tighter monetary policy and higher interest rates, which hurt housing and consumer durables.
   
   
2. Domestic inflation causes manufacturing firms to price themselves out of international markets, thus reducing the growth in exports.
   
   
3. Firms have not controlled their costs vigorously, so eventually they institute massive layoffs, hence reducing the growth in personal income and boosting the unemployment rate.
   
   
4. Rising prices and fears of shortages causes firms to overstockpile inventories, leading to sharp cutbacks in production when the deficiency in demand is finally revealed.
   
   
5. The combination of higher interest rates, lower cash flow, and sluggish demand leads to a decline in capital spending, thus certifying and deepening the recession.

The only hint of any of these developments so far this year has been number 1. The Fed has not found it necessary to tighten; instead, market forces did the trick with an average increase of 1 percent in market interest rates during the first half of this year. This resulting decline in retail sales and housing has led to concerns that continued robust gains in production would thus lead to an inventory imbalance and much slower growth.

Yet the September APICS figures contain no sign of any such development. Indeed, production is expected to rise at a more rapid rate this quarter than it did in the third. The only sign of weakness was the drop in manufacturing employment but that can also be interpreted as a positive sign in the sense that firms remain lean, hence further reducing the chances of massive cutbacks later on in this cycle.

Some day, say the pundits, all this must come to an end. We would hardly disagree with that general proposition. However, until clear and present evidence of the warning signals 1-5 arises, we will continue to predict continued prosperity in the months and quarters ahead.

APICS Index Performance

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APICS Business Outlook Index

Maximum feasible value = 100
CURRENT COMPONENT
	SHIPMENTS	EMPLOYMENT	PRODUCTION	INVENTORY	CURRENT COMPONENT	TOTAL APICS INDEX*
1995
OCT	57.1	42.8	46.6	46.0	48.1	49.5
NOV	56.6	34.6	38.9	35.3	41.3	44.8
DEC	43.4	43.3	44.4	44.1	43.8	43.8
1996
JAN	59.7	42.1	50.0	37.9	47.4	49.4
FEB	58.6	40.9	61.1	37.1	49.4	49.2
MAR	34.8	43.3	37.0	31.8	36.7	42.9
APR	73.0	55.6	73.2	43.2	61.3	56.2
MAY	53.5	43.3	41.7	45.7	46.1	45.6
JUN	51.5	43.5	57.1	48.5	50.2	50.1
JUL	58.7	45.6	57.7	43.7	51.4	53.0
AUG	42.9	52.5	46.3	39.9	45.4	46.4
SEP	63.3	43.3	56.0	51.8	53.6	53.8

FUTURE COMPONENT
	NEW ORDERS	UNFILLED ORDERS	PRODUCTION PLANNING	I/S RATIO	FUTURE COMPONENT
1995
OCT	51.9	48.0	48.3	55.7	51.0
NOV	45.3	39.6	55.4	53.1	48.3
DEC	37.1	45.5	50.0	42.6	43.8
1996
JAN	48.2	43.1	52.1	61.7	51.3
FEB	50.2	39.7	45.9	60.0	49.0
MAR	50.0	51.5	53.6	40.9	49.0
APR	55.6	36.5	48.4	64.2	51.2
MAY	40.9	44.8	46.6	48.5	45.2
JUN	51.6	50.1	51.7	47.0	50.1
JUL	55.0	53.3	51.9	58.5	54.7
AUG	43.5	45.6	53.6	47.0	47.4
SEP	56.9	51.7	54.0	53.6	54.0
* Current and Future Components with equal weights

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