December 1996 € Volume 6 € Number 12

Slower Growth on the Near-Term Horizon

By Michael K. Evans

The APICS Business Outlook Index fell to 49.1 in October from 53.8 in September. The Current Component declined to 47.7 from 53.6, while the Future Component fell to 50.6 from 54.0.

Last month, the APICS index was quite accurate, calling for big gains in shipments and new orders at the same time that employment dropped sharply. We do not expect a similar dichotomy in October; activity is muted for almost all indicators.

Unlike last March, when the General Motors strike pulled the Current Component of the APICS index way down to 36.7 but the Future Component remained near 50, the various work stoppages associated with the Canadian GM strike during October do not seem to have had much impact on these numbers.

Instead, the significant declines in shipments, new orders, and unfilled orders taken together suggest that higher interest rates on discretionary consumer spending and housing are now starting to take their toll on the manufacturing sector.

On the bright side, production plans for the next three months are still reasonably robust, showing a slight pickup in the next three months relative to normal seasonal patterns. Also, the data do not provide any evidence that excess inventory stocks are beginning to accumulate. Nonetheless, the economy appears set for another bout of slower growth over the next few months.

• Manufacturing Shipments slackened in October, rising an estimated 0.3 percent. In September, the APICS survey called for a 1 percent rise; preliminary figures show durable goods shipments up 1.4 percent for the month, so the gain in total shipments should be right around the 1 percent mark.
• Manufacturing Employment is expected to continue its normal decline in October, falling about 15,000. Last month the Bureau of Labor Statistics (BLS) said it fell 57,000, which is meaningless unless taken in context with the reported 18,000 gain in August, which didn't happen either. The fact remains that manufacturing employment continues to fall about 15,000 per month, as it has for the past year and a half&emdash;and a few aberrant BLS seasonals don't change that.
• Manufacturing Production remains sluggish, with no change expected this month. Last year, the Fed said production fell 0.5 percent in October. The APICS index had been predicting sluggish growth in production all summer, and finally the Fed revisions fell into line with these estimates, as the average monthly rise in production this summer was revised down from 0.4 to 0.2 percent. For October, the survey indicates that production will be flat.
• The APICS survey continues to show smaller gains in Manufacturing Inventory Stocks than does Census; apparently there are some differences in the way we collect the data. Our numbers usually show a smaller gain. In any case, inventories remain well under control, indicating no reason to expect any reduction of stocks. According to our figures, inventory stocks fell about 0.3 percent in October; that would translate into roughly no change on the Census basis.
  
  
  

Future Conditions Component

• New Orders, excluding aircraft and defense, showed virtually no change in October. Last month, new orders soared 4.6 percent; excluding aircraft and defense, the increase was 1.7 percent, right in the middle of our estimated range of 1.5 to 2 percent gain.
• Unfilled Orders rose in September, with a preliminary gain of 0.6 percent. In October, however, the lack of any gain in new orders, coupled with a modest rise in shipments, suggests that unfilled orders fell about 0.3 percent for the month, another sign of slackening activity in the months ahead.
• Production Planning for the next three months indicates that the current slowdown will not turn into a recession, with an average monthly gain of 0.2 percent in manufacturing production. Last year, production showed virtually no increase from October through the following January; this year, a more normal seasonal pattern is likely to occur.
• The ratio of the actual to desired level of the Inventory/Sales (I/S) ratio remains low, with no sign of excess inventories in these data. Only 41.4 percent of the firms say their actual I/S ratios are above desired levels. This is an impressive finding in the sense that most firms usually think they could do better in reducing their inventories, so that ratio is usually above 50 percent. Also, 60 percent of the firms reported a decline in the actual to desired I/S ratios in October. Thus it seems clear, at least based on these survey results, that inventory stocks remain well under control and will not be a factor that would intensify the current slowdown.
  
  
  

The pause that refreshes
The economy is heading into another slowdown, but we see no chance that it will turn into an outright recession. Instead, this appears to be another "rolling adjustment" similar to the one that occurred in 1995, but this one should be even milder for several reasons. The inventory buildup has been absent this time, interest rates did not rise nearly as much in the first half of 1996 as they did in 1994, and exports should continue to rise at normal rates instead of taking a sharp dip, as they did in early 1995 when the Mexican economy collapsed.

Back in 1976, some wag called the slowdown that year "The Pause That Refreshes," suggesting that a welcome slowdown in the growth rate would keep the economy from overheating. As it turned out, that stop-go pattern didn't work out very well, because once the economy started rising at above-average rates, inflationary pressures built to the point where the Consumer Price Index eventually soared 13.5 percent in 1980.

This time around, though, the aphorism seems more appropriate. At least as measured by the Bureau of Economic Analysis (BEA), real growth cannot exceed 2.5 percent without severely straining the use of available resources (we think the actual growth rate is about 3.5 percent because the contribution of the high tech industry is woefully understated, but that's another issue). Thus if the economy rises at a 3.5 percent rate in one half of the year, it has to increase only 1.5 percent in the other half in order to keep both product and factor markets in equilibrium.

Over the past 15 years, interest rates have done a very good job at equilibrating this growth rate. The only recession that did occur during that period was in large part due to exogenous factors: the Persian Gulf War and the shortage of credit following the S&L crisis.

Thus it is no surprise that the 1 percent rise in interest rates in the first half of the year has resulted in slower growth in the second half. The slowdown started in discretionary consumer spending and housing; the October figures are the first major sign that it has spread to the manufacturing sector.

Looking beyond the horizon of this survey, the decline in interest rates since they reached their June peak has been very limited considering that the growth rate has slowed at least by half from its second quarter rate. There seem to be two main concerns: potential for Democratic control of Congress and higher inflation stemming from rises in wages and oil prices.

While these concerns are understandable, we think they are overblown and will dissipate after a few months. As soon as that happens, interest rates will fall another 0.5 to 1 percent, which in a few months will boost real growth, sending it back to the 3 percent range by mid-1997.

In the interim, though, October new orders are flat instead of declining, inventory stocks remain lean, and the production planning component shows about a 3 percent annual growth rate for the next three months. These all indicate that the slight rise in interest rates in the first half of this year was not sufficient to damage the economy&emdash;it merely slowed the growth rate enough that the expansion can continue indefinitely.

A methodological note: Some have wondered why the APICS index bounces around so much more from month to month than other monthly indexes. We are tempted to say "because that's what actually happens," but the issues are slightly more complicated than that. The biggest monthly fluctuation in the Current Component index, namely the decline in March and rebound in April, was tied to the GM strike; the fluctuations in the summer months reflected the fact that there were fewer shutdowns in July. The current component is supposed to provide the first snapshot of what happened in the month just ended, and to predict either what the government statistics will show, or indicate where our methodology will lead to different results.

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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
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
OCT	53.0	45.2	50.2	42.4	47.7	49.1

FUTURE COMPONENT
	NEW ORDERS	UNFILLED ORDERS	PRODUCTION PLANNING	I/S RATIO	FUTURE COMPONENT
1995
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
OCT	50.5	45.7	55.1	51.1	50.6
* Current and Future Components with equal weights

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