By Michael K. Evans

The APICS Business Outlook Index climbed further in April, rising to 53.4, up from 51.1 in March. The current component of the index rose to 52.9 from 50.4, while the future component increased to 54.0 from 51.9. All components of the index registered 50 or higher except for inventory stocks, which remain unusually lean, and unfilled orders, which fell slightly in view of the strong gain in shipments. Gains in shipments and production were especially strong.

With the exception of the recovery from the General Motors strike a year ago, the APICS index has now risen to levels last seen during 1994. Hence the strong growth that occurred in the first quarter is likely to continue well into this year, and was not just a one quarter fluke dominated by mild winter weather and other special factors.

If there is one cloud on the horizon, it is probably that the gains this quarter in manufacturing production and overall economic activity are likely to stem in part from a rebuilding of inventory stocks, which are now at unusually low levels. The rapid gains in shipments and production last quarter were matched by declining stocks, according to the APICS index, which points to a rebound in inventory investment during the next few months.

However, the strong gain expected for April manufacturing employment should help keep real disposable income rising at above-average rates, which should, in turn, provide further stimulus to consumer spending. With strong growth also expected in capital spending, the above-average rise in overall economic activity this quarter will be due to several factors, not just a rebuilding of inventory stocks.


Current Conditions Component

• Manufacturing Shipments rose about 1 percent in April, continuing the strong pace of the first quarter, when the Commerce Department reported an average monthly gain of 1.2 percent.
• Manufacturing Employment continued its robust gains in April, with an estimated increase of 20,000. This would be the seventh consecutive month of a rise in manufacturing employment, except for a tiny setback in February that should be erased in forthcoming revisions.
• Manufacturing Production rose an estimated 0.5 to 0.6 percent in April, continuing the strong increases of the past two months. The figure for production reported by the Federal Reserve Board for April might show a smaller gain because of strikes in the automobile industry.
• The backlog of Unfilled Orders remains strong, but slipped a little in April because of the much larger gain in shipments than in new orders. Hence we look for a decline of about 0.1 percent for order backlogs, excluding aircraft and defense.
• Manufacturing Inventory Stocks remain at very low levels. Firms have not yet adjusted to the unexpectedly strong rise in shipments and orders in the first quarter. Thus inventory investment is likely to rise this quarter — but the gains will probably be less than in 1994 because commodity prices are flat and there are no shortages or bottlenecks this year.

Future Conditions Component

• New Orders for durable goods, excluding aircraft and defense, edged higher in April, rising about 0.5 percent. The March decline reported by the Commerce Department has to be tempered with the big increases in January and February; on balance, new orders are still rising in general, and those for capital goods are improving.
• The index for Production Planning has declined to 50, which means little change from current rates of growth. However, since production had been surging over the past three months, this means that the rapid rate posted for February through April is likely to continue for the next three months.
• The actual to desired Inventory/Sales ratio fell sharply in April; since this series enters the index on an inverted basis, the index jumped from 50.0 to 59.1. This provides further support to the forecast that inventory investment will increase during the next few months.

Strong growth seen for remainder of 1997
According to the APICS index, real Gross Domestic Product will rise at close to a 4 percent annual rate in the second quarter, marking the third consecutive quarter with real growth at that level. Thus the economy will be advancing as fast as it did from 1993.4 through 1994.3. Before that, we must go back to 1988 to find a period of such rapid growth.

The big difference now is that in both 1988 and 1994, inflationary pressures were rising rapidly, as measured by various measures of commodity prices: sensitive materials prices, and finished, intermediate and crude producer prices. However, there is no evidence of any increase in commodity price inflation so far this year.

The Employment Cost Index rose 4.8 percent in 1988 and 1989, a figure that was instrumental in pushing the CPI inflation rate to 4.5 percent. However, gains in employment costs receded over the next several years, and rose only 3.1 percent during 1994. The latest Employment Cost Index (ECI) report shows they advanced only 0.6 percent last quarter and 2.9 percent over the past 12 months — further evidence that wage inflation remains well under control. In further support of that hypothesis, the Consumer Price Index (CPI) rose at an annual rate of only 2.4 percent last quarter.

If commodity prices are flat, the CPI is slowing down, and the gains in employment costs are diminishing, then where is the inflation that worries the Fed so much?

It is not our point here to determine whether Greenspan & Co. are doing the "right" thing. Rather, it is to emphasize that even if the Fed does tighten further — and another rate hike on May 20, long rumored to be a near-certainty, may now be postponed — investors can see that inflation is not accelerating, and hence bond yields may not rise further. If that turns out to be true, then the .25 percent rise in the funds rate, except for causing some upset stomachs in the stock market, would have virtually no impact on real growth this year.

Last month we wrote that the "betting odds" favored an increase in the Federal funds rate to 6 percent and the Treasury bond rate to 7.5 percent later this year. Until the release of the Employment Cost Index report on Tuesday, April 29, that was indeed the case. However, the exceptionally low gain in employment costs has shifted the odds to the point where they no longer favor further interest rate hikes in the near term. In that case, our forecast of above-average growth for the rest of 1997 is strengthened further.

The latest APICS results clearly support that forecast, at least for the current quarter. Yet while our survey horizon does not extend past three months, we can find no reason why the growth rate would drop substantially in the second half of the year.

The key to continued robust expansion of the economy is, of course, rapid gains in consumption and capital spending. Last month we emphasized that strong gains in real wages and salaries were instrumental in propelling retail sales to a 15 percent annual rate during the first three months of the year. While that is clearly unsustainable, it is indicative of the current strength in consumer purchasing power. Recently, real disposable income rose at an annual rate of 6.5 percent, and another strong gain is expected in March.

For a while it seemed that capital spending growth would slacken this year. While the high-tech sector continues to expand at double-digit rates, the big increase in industrial capacity put in place since 1994 augured for slower growth in that key sector of the economy. However, over the past five months, manufacturing industrial production has risen at such a rapid 8 percent annual rate that industrial investment is also likely to post larger gains later this year.

As Greenspan himself said at the close of his Humphrey-Hawkins testimony this year, "Even I must admit that our economic prospects in general are quite favorable." With consumer spending and purchases of capital goods both poised for further gains, production set to receive an additional boost from rebuilding of depleted inventory stocks, and no increase in inflation, the outlook does indeed seems bright for the rest of this year.

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

Maximum feasible value = 100
CURRENT COMPONENT
	SHIPMENTS	EMPLOYMENT	PRODUCTION	INVENTORY	UNFILLED ORDERS	CURRENT COMPONENT
1996
MAY	53.5	43.3	41.7	45.7	44.8	46.1
JUN	51.5	43.5	57.1	48.5	50.1	50.2
JUL	58.4	45.6	57.7	43.7	53.3	51.4
AUG	42.9	52.5	46.3	39.9	45.6	45.4
SEP	63.3	43.3	56.0	51.8	51.7	53.6
OCT	53.0	45.2	50.2	42.4	45.7	47.7
NOV	46.7	43.7	52.1	50.8	46.6	48.3
DEC	59.5	54.5	50.0	41.0	49.7	51.2
1997
JAN	38.5	51.4	43.8	37.2	40.5	42.3
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

FUTURE COMPONENT
	NEW ORDERS	PRODUCTION PLANNING	I/S RATIO	FUTURE COMPONENT	TOTAL APICS INDEX*
1996
MAY	40.9	46.6	48.5	45.2	45.6
JUN	51.6	51.7	47.0	50.1	50.1
JUL	55.0	51.9	58.5	54.7	53.0
AUG	43.5	53.6	47.0	47.4	46.4
SEP	56.9	54.0	53.6	54.0	53.8
OCT	50.5	55.1	51.1	50.6	49.1
NOV	41.9	49.3	43.3	45.3	46.8
DEC	55.3	47.5	57.1	52.4	51.8
1997
JAN	41.7	56.5	50.7	49.6	45.9
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
* Current and Future Components with equal weights

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