A reading of 50 indicates little change in overall manufacturing activity. As a result, industrial production in October is expected to be unchanged, with a further decline in manufacturing employment. The lack of any change in production appears to reflect two opposing trends: Shipments are rising, while inventory stocks are declining. Firms are trying to reduce inventory stocks, which will cause production to lag behind shipments for a few months.
A reading of 50 is also consistent with an overall real growth rate of 0.5 to 2 percent. The third quarter National Income Products Account figures, which showed real gross domestic product (GDP) rising at 4.2 percent on the old basis and 3 percent on the new basis, would appear to be well above these levels. However, we believe those figures overstate the actual growth rate.
With new orders rising at a modest rate for the second month in a row, it is likely that production will start rising as soon as inventory stocks have fallen to desired levels. In the meantime, production and overall economic activity should remain sluggish.
Current Conditions Component
Future Conditions Component
Overall growth remains at below-average rates
This headline may appear to fly in the face of the third quarter GDP statistics, which showed real growth at 4.2 percent on the old basis-well above the long-term sustainable growth rate-and 3 percent on the new basis.
We had estimated that final sales rose about 3 percent and GDP rose about 2 percent on the new basis in the third quarter. Our final estimate agrees with the preliminary Bureau of Economic Analysis (BEA) figures; the inventory investment estimate does not. We thought inventory investment would decline $10 to $15 billion; BEA says it rose $l billion. Since BEA used preliminary and missing information, we believe the figure will be revised downward.
Even if it were to turn out that inventory investment was overstated by BEA, it can still be argued that growth in real final sales is 3 percent, and real GDP will rebound to that level as soon as the downward inventory adjustment had ended. According to the APICS results, that termination is likely to occur by year end, so real growth might bounce back to 3 percent starting in early 1996. However, that is not our forecast.
Looking at the third quarter GDP figures, of the $40 billion increase in real final sales on the new basis, $22 billion occurred in consumer spending, $4 billion in capital spending, $6 billion in housing, $l billion in net exports, and $7 billion in government purchases. The last category can be disregarded because it represents an attempt to spend funds by the end of the fiscal year. It happened last year, when Federal purchases rose $9 billion in 1994.3 but fell $13 billion in 1994.4.
Assuming capital spending and net exports do not suddenly rebound, the question of whether the growth in real final sales can remain near the 3 percent mark depends on whether consumer spending and housing can keep growing at third quarter rates. The evidence suggests a loud negative answer.
Since June, consumption of goods in real terms (on the new basis) has not risen at all, compared to a 6 percent annual rate during the previous three quarters. Because of the vicissitudes of the monthly data, this sharp slowdown has not yet shown up in the quarterly data, but it will this quarter. Employment gains have been anemic, interest rates have stopped declining, the debt/income ratio is at an all-time high, and consumer loan delinquencies rose sharply last quarter.
Housing starts peaked in July and have declined slightly since then, with further reductions expected. Thus, residential construction will not rise very much this quarter.
Capital spending is not likely to pick up either. If we abstract from the monthly fluctuations in the Commerce Department series and concentrate on the quarterly aggregates, the figures for new orders of nondefense capital goods, excluding aircraft, have been flat for the past two quarters. Similarly, the APICS figures show an average of 50.1 for the most recent three months, compared to 48 for the previous three months and, for that matter, 47.6 in the three months before that. Thus, while new orders have improved slightly, that is not the sort of result that will lead to a resurgence of the capital goods boom next year.
We can now tie these outside observations to the results obtained from the latest APICS survey. Based on these results, the ongoing decline in inventory stocks has not yet been completed. On the other hand, based on the improvement in the actual to desired I/S ratio, it probably will by year end.
The economy is not heading into recession; if it were, new orders would not show the slight increase recorded for the past two months. The high-tech boom is still alive; we look for a 4 to 5 percent gain in real producer durable equipment next year.
However, the critical factor of how fast the economy will grow in 1996 depends on production and employment, which will be the major factor driving consumer spending now that borrowing restraints are starting to tighten. The figures could improve next year, but currently they show only sluggish gains in production, coupled with a steady 2 percent annual rate decline in manufacturing employment. If it continues to decline at this rate, real disposable income, excluding transfers, will not rise, and neither will consumption of goods.
There is always the possibility the Fed will ease enough to boost real growth to above-average rates, as it did in late 1991 and 1992. At the moment, though, GDP statistics point to no near-term Fed easing, while the APICS survey results indicate that actual growth is well below the BEA estimates. Hence, the growth rate will decline further for the next few months.
Click here for a graph of APICS Index performance over the last 12 months.
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