APICS - TPA - March 1998 - APICS Business Outlook Index

March 1998 • Volume 8 • Number 3

APICS Business Outlook Index:

Slowdown on the Horizon, But Not Here Yet

By Michael K. Evans, Ph.D.

The APICS Business Outlook Index slipped further in January, falling to 46.8 from 48.6 in December. However, the split of the past three months continued, with the current component again registering higher values than the future component. The current component rose slightly, climbing to 51.8 from 50.1, while the future component sagged further, dropping to 41.9 from 46.1.

Over the past four months, the current component has averaged 50.4, while the future component has averaged only 43.6. Survey firms report that new orders are lower, inventory stocks are above desired levels and production plans call for virtually no gain over the next three months. On the other hand, firms are still boosting current production and are hiring more workers. In particular, the employment component of the APICS index rose sharply to 57.8 in January, up from 51.7 in December.

Thus, while it seems increasingly likely that a slowdown will develop in the next few months, the January data indicate it has not yet started. Firms are still trying to fill vacant positions, which boosts aggregate personal income and contributes to continuing robust domestic demand. While an increasing proportion of firms indicate weaker orders due to the collapse of the Southeast Asian economy, these have not yet been translated into a decline in current manufacturing activity. Hence, the initial reaction to that crisis may have been overstated.

Current Conditions Components

Manufacturing Shipments were unchanged again in January. After correctly tracking the decline in shipments in October and November, the APICS index failed to show an increase commensurate with the 1.5 percent rise in durable goods shipments for December reported by the Commerce Department. However, we do not expect that gain to be repeated in January, and we think it might be reversed in the government figures.

Manufacturing Employment posted another big gain in January, rising an estimated 32,000. Last month, the survey underestimated the 39,000 gain reported by the Bureau of Labor Statistics (BLS). Apparently, firms continue to add employees even as order backlogs shrink. With the unemployment rate having fallen to 4.7 percent, wages are finally starting to accelerate, indicating that some firms are now willing to pay the higher wage rates to attract needed personnel.

Manufacturing Production is expected to rise 0.3 percent in January, down from 0.5 percent in December. During the past three months, manufacturing production reportedly rose at an unsustainable annual rate of 10.0 percent; that rate is almost certain to decline sharply in early 1998.

Durable Goods Unfilled Orders declined an estimated 0.1 percent in January, as new orders declined, while shipments were virtually unchanged. Last month, the preliminary government figures indicated a 0.4 percent drop in durable goods unfilled orders, slightly higher than the APICS estimate of a 0.2 percent decline.

Inventory Stocks continued to move slightly higher, rising an estimated 0.1 to 0.2 percent in January. The fact that the actual-to-desired inventory/sales ratio is also rising suggests that most of the recent accumulation in inventories reflects sluggish sales rather than an attempt to boost stocks because of robust business conditions.

Future Condition Components

New Orders fell an estimated 2 percent in January; the index had predicted a 1 percent drop in December. We have recently received several questions about why our series excludes aircraft and defense orders; last month was a perfect example. According to the preliminary government figures, total durable goods new orders fell 6.1 percent but, excluding aircraft, then rose 0.7 percent. In other words, aircraft orders dropped $13.5 billion, while all other orders rose $1.5 billion. Since these huge swings in aircraft orders are not indicative of underlying developments in the overall economy, they are excluded from our calculations.

The index for Production Planning indicates an increase of approximately 0.1 percent per month in manufacturing production over the next three months. Since October, firms have not cut back on their production plans as much as originally anticipated.

The actual-to-desired Inventory/Sales Ratio rose substantially in January, indicating that the build-up in inventory investment was greater than desired. Thus, as soon as the rail transportation system in the U.S. gets back on schedule, we would expect to see some reduction in inventory stocks.

Why the Current Component is Stronger than the Future Component
On January 27, the BLS announced that the employment cost index (ECI) for private sector workers last quarter rose 1.2 percent (i.e., an annual rate of 4.8 percent). During the previous seven quarters, this index had risen an average of only 0.7 percent per quarter. This seems to us to be clear and present evidence that the decline in the unemployment rate to 4.7 percent has finally caused some acceleration in wage gains. Yet the announcement of the ECI report went almost unnoticed.

Ordinarily, news that labor costs were now growing 5 percent instead of 3 percent would have set off all sorts of alarm bells in debt markets, with bond yields rising sharply and market pundits rushing to be the first to announce that the Fed was about to tighten. However, these sometime seers have been anaesthetized by the collapse of many countries in southeast Asia, the plunge of those currencies, and the opiate of sharply lower import prices in the months ahead. They also believe the Fed would not dare to tighten while the world is still wondering if Korea, Indonesia, Thailand and Malaysia will ever be able to pay back their loans.

This raises a range of scenarios that have not recently been considered. Usually when the economy shows signs of overheating, interest rates rise and take some of the steam out of inflationary pressures. That hasn�t happened recently, as most interest rates (excluding the Federal funds rate itself) have headed lower over the past several months. Economists generally have focused too much attention on the drop in growth stemming from lower exports, and not enough on the rise in growth stemming from lower interest rates.

The flip side of higher employment costs is bigger wage gains and greater purchasing power for consumers. Suppose workers receive fatter paychecks, while at the same time interest rates and inflation do not rise. As the Consumer Price Index rises more slowly because of the temporary decline in energy costs, real disposable income and consumer spending will increase. Those gains, which are reflected in the current component of the APICS survey, have so far eclipsed the drop in export shipments to southeast Asia.

How will all this turn out? One fine morning when bond traders report for work, it will dawn on them that inflationary pressures are increasing in spite of the reduction in the price of imported goods from southeast Asia. That will be the signal for bond rates to rise, and eventually the Fed will follow suit. We don�t know the precise day when that turnaround will occur, but once interest rates have started to rise, it takes at least two quarters before higher rates reduce economic activity. Indeed, the recent strength of the economy clearly reflects the decline in bond yields of almost 1.5 percentage points from last April until early January.

One can readily understand why APICS survey participants, as well as other business executives, have become more pessimistic about the outlook in recent months; the decline in export growth this year will certainly be dramatic. On the other hand, the economy is still benefitting from the rise in domestic demand spurred by lower interest rates and bigger increases in the real wage. These two factors have caused the economy to continue rising at above-average rates.

Thus we expect this dichotomy — current conditions stronger than future expectations — to continue until the recent acceleration in wage gains is translated into higher inflation and interest rates.

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

APICS Index Performance

The APICS Business Outlook Index was created and developed by Michael Evans of Northwestern University, in conjunction with APICS. The index consists of the following components, based on Evans' monthly survey of participating manufacturing firms:

•CURRENT CONDITIONS COMPONENT: Manufacturing shipments, employment, industrial production, inventory stocks

•FUTURE CONDITIONS COMPONENT: Future Component lagged 2 months. Durable goods new orders (excluding aircraft and defense), production plans, unfilled orders, ratio of actual-to-desired inventory/sales ratio APICS members and others from companies that might be potential participants in the APICS Business Outlook Index are urged to call Dr. Michael Evans at (847) 328-2468. APICS staff contact for the index is Barbara Gleason, APR, senior communications manager, APICS Headquarters, (703) 237-8344, ext. 2271. APICS Index Performance

APICS Business Outlook Index

Maximum feasible value = 100

CURRENT COMPONENT

Shipments
Employment
Production
Inventory
Unfilled Orders
Current Component

1997

FEB
47.5
56.1
53.2
39.7
47.4
48.8

MAR
47.5
48.9
53.2
46.1
56.3
50.4

APR
61.1
54.4
57.1
44.1
47.8
52.9

MAY
54.4
56.9
56.3
47.5
48.8
52.8

JUN
45.2
54.1
60.6
47.2
52.6
51.9

JUL
57.3
59.8
54.9
41.2
48.7
25.4

AUG
39.6
60.2
41.9
54.6
55.7
50.4

SEP
59.8
53.7
60.6
47.5
54.4
55.2

OCT
44.0
53.5
48.8
62.1
44.7
50.6

NOV
40.7
54.9
48.5
53.7
47.6
49.0

DEC
48.6
51.7
50.0
55.9
44.3
50.1

1998

JAN
48.1
57.8
52.7
52.9
48.4
51.8

FUTURE COMPONENT

NEW ORDERS

PRODUCTION PLANNING

I/S RATIO

FUTURE COMPONENT

TOTAL APICS INDEX*

1997

FEB
43.6
48.4
48.8
46.9
47.8

MAR
49.3
56.5
50.0
51.9
51.1

APR
52.9
50.0
59.1
54.0
53.4

MAY
55.6
53.9
50.0
53.2
53.0

JUN
47.2
60.0
51.4
52.9
52.4

JUL
56.4
48.5
56.2
53.7
53.0

AUG
42.9
44.8
46.2
44.6
47.5

SEP
52.6
51.6
56.3
53.5
54.3

OCT
36.9
47.9
33.8
39.5
45.1

NOV
52.6
44.8
42.7
46.7
48.2

DEC
42.2
46.0
50.0
46.1
48.6

1998

JAN
37.2
48.6
40.0
41.9
46.8

* Current and Future Components with equal weights

Copyright © 1998 by APICS — The Educational Society for Resource Management. All rights reserved.

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