By Michael K. Evans

All of the components registered 50 or better for the second month in a row except for inventories, which came in at 47.5, and unfilled orders, which registered 48.8.

The strongest components in the index were employment and production, both of which snapped back from strike-related declines in April that were reported in the government figures. By comparison, the Commerce Department figures, as well as the APICS survey results, showed better than a 1 percent increase in manufacturing shipments for April, so the gain in that component should be correspondingly smaller in May.

The overall index figure of 53 suggests that the manufacturing sector should be rising at about a 4 percent annual rate, not only in May, but for the next three months as well. That would translate into about a 3.5 percent annual rate gain in total real Gross Domestic Product (GDP), assuming about a 3 percent gain in the service sector.

The latest survey results strongly suggest that the weakness seen in many government statistics — although not in the APICS numbers themselves — is due to wet weather and strikes in the auto industry, rather than a slowdown in the underlying growth rate of the economy. In particular, there does not yet seem to be any evidence that the slight rise in interest rates this year is dampening economic activity.


Current Conditions Component

• Manufacturing Shipments rose about 0.5 percent in May, down somewhat from the 1.1 percent gain reported for durable goods shipments in April. The APICS survey had predicted a 1 percent gain for last month, almost identical to the government number.
• Manufacturing Employment rose an estimated 25,000 in May. Last month, according to the Bureau of Labor Statistics, it fell 14,000 because of the auto strikes. Except for those strikes, employment probably would have risen about 5,000. The Chrysler strike was settled by the time the May employment survey was taken; the General Motors strike is now settled, but was still in force during the week of May 12.

If these factors are superimposed on an otherwise robust economy, the published figures for manufacturing employment will rebound sharply this month; however, the returning strikebreakers must be subtracted to obtain an estimate of underlying strength in the economy. Excluding those employees, manufacturing employment rose about 10,000 in May.

• Manufacturing Production increased an estimated 0.6 percent in May. Last month, the APICS survey results overstated the gain by underestimating the negative impact of the auto strikes. Settling the Chrysler strike will add about 0.3 percent to the manufacturing index, which means the underlying increase for May would also be 0.3 percent.
• Unfilled Orders were almost unchanged in May, as both shipments and new orders posted relatively strong gains. At the moment, the survey results indicate little change in order backlogs, excluding defense and aircraft.
• Manufacturing Inventory Stocks are still weakening, but at a slower pace. Government figures for April inventory stocks are not yet available, but considering the decline in production, especially in the auto industry, inventory stocks probably fell slightly. In May, the APICS survey indicates a 0.1 percent drop in inventory stocks.
  

Future Conditions Component

• New Orders for durable goods, excluding aircraft and defense, posted another robust gain in May, rising about 1 percent. Last month, the APICS survey called for a 0.5 percent gain, compared to the consensus estimate of a 1 percent decline; the preliminary government figures for this category showed an 0.8 percent increase.
• The index for Production Planning over the next three months indicates continued robust gains, which should average about 0.4 percent per month for the June-August period. This component of the index improved from 50.0 in April to 53.9 in May, suggesting no signs of slowdown this summer.
• The ratio of the actual to desired Inventory/Sales Ratio fell to 50.0 in May. The ratio had risen to 59.1 in April; this is an inverted series, so an increase in the figures indicates that firms have a lower actual I/S ratio relative to desired levels. With the slower growth in sales for May and a smaller drop in inventory stocks, this ratio has moved back to 50, which means no pressure either to increase or decrease stocks relative to expected changes in sales.
  

False signs of slowdown in April
The April APICS report raised a few eyebrows when it showed continued strength in the economy in April, especially as industrial production fell and employment gains were moderate. When combined with a very modest gain in the first quarter Employment Cost Index, the Federal Open Market Committee decided not to tighten further on May 20. The unspoken message was that the growth rate of the economy had declined enough that inflation was no longer a threat.

The APICS report doesn't measure inflation, but based on the figures in these reports, signs of below-average growth are, at best, premature and may not even exist at all. It is quite clear that no one expects a repeat of the reported 5.6 percent gain in real GDP last quarter. However, the underlying data — production, sales, employment, and income — do not support such a lofty number, suggesting instead that real growth last quarter was probably about 4 percent.

Based on emerging trends in the economy and the data in the April and May APICS reports, we estimate that real GDP will rise about 3.5 percent this quarter; and that growth rate will also remain intact in the second half of the year.

The widely observed but misleading slowdown in April appears to have been caused by more or less equal contributions from the auto strike and the cold, wet weather, which inhibited shoppers from venturing forth at their accustomed pace. Construction activity was also slowed by the April rains.

However, other signals show a much different picture. Consumer confidence rose to a 28-year high in May, and several firms have reported that June graduates will find jobs more readily than at any other time in this decade. Profits also continue to post robust double-digit gains, which should boost capital spending throughout the year. In short, we do not see any signs of emerging weakness.

Some claim that the big gain in inventory investment last quarter will point to slower growth this quarter. According to the APICS numbers, though, that first-quarter gain is overstated, and should eventually be revised down. Our results indicate that inventory stocks are lean, with firms reporting that their actual inventory/sales ratios are right in line with their desired ratios (adjusting for the bias that most firms think they could do a little better). Hence these data do not indicate any upcoming change in production for inventories; since production for final sales remains robust, the growth rate should not decline.

Changes in monetary policy invariably affect the economy with a two- to three-quarter lag, and we see no reason why that lag should change this year. Hence, even if the .25 percent rise in the funds rate in late March and the 0.5 percent rise in bond yields that started in March were both to have a powerful effect on the economy, any slowdown would not occur until autumn. It is quite fanciful to believe that interest rate hikes in March caused real growth to decline in April.

Also, the slight rise in rates will have virtually no impact on real growth, so long as credit conditions remain unchanged. While some banks are courting new consumer accounts less aggressively, they are offering to lend to businesses at more favorable terms. As a result, overall credit conditions have not been changed by the recent hikes in interest rates.

The expected gains in new orders and production planning shown in the May APICS survey thus suggest no cutbacks in the next few months. Real growth should remain at above-average rates for the remainder of 1997.

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