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No Boom, No Bust

Manufacturing growth will slow in 2015.

Robert Johnson, CFA, 04/02/2015

Concerns over the manufacturing sector are one of the primary reasons we are less bullish on the U.S. economy. (My forecast is 2% to 2.5% growth versus a consensus forecast of 3% growth for 2015.) Although manufacturing is just less than 10% of U.S. employment, it has an outsize impact on the U.S. economy, partially because of the high hourly wages workers receive for one of the longest available work weeks compared with other sectors.

Industrial production for the manufacturing sector grew a very strong 4.5% in 2014, outpacing the 2.7% average pace of the past 50 years and the U.S. GDP growth rate of 2.4% for all of 2014. I suspect that with slowing exports, declining growth rates in the auto sector, and reduced drilling equipment needs, manufacturing growth will slow in 2015. Some of the slowing is visible in the month-to-month growth figures that showed a gain of just 0.2% (2.4% annualized). Year-over- year data is a different story. Weather issues a year ago depressed January results, causing a huge year-over-year gain (6% for the single-month comparison).

The good news is that month-to-month data is in positive territory, which would seem to indicate that the manufacturing sector is not falling apart. Much like the purchasing managers’ data and durable goods orders, growth rates in manufacturing businesses in the near-term data are not as robust as they once were, but things aren’t collapsing, either.

The sector data is slightly more troubling, with autos, airliners, petroleum products, and furniture showing declines. These were some of the stronger sectors of 2014. Oddly, things that go into those products—primary metals, wood products, and fabricated metals—all showed hefty gains and were some of the best performers in January. Either these improvements are precursors to better end-market production, or these sectors couldn’t cut back fast enough. Only time will tell, though it seems odd that the metals-related categories would be doing so well now. On the bright side, computer shipments were also especially strong, which is unusual for the first month of a quarter. Computer buyers are notorious for buying their machines at the very end of a quarter to extract the best deals from manufacturers.

Weather Hits Auto Sales
Auto sales for February came in at 16.23 million units, sharply below estimates of 16.7 million annualized units. They were also lower than the 16.74 million units sold in January. The doom-and- gloomers are trumpeting the third straight monthly decline and the lowest reading since all the way back to last April. The optimists among us noted that sales were 5% above year-ago levels and this was the best February since 2006. And the improvement came despite some pretty lousy weather in both periods and a change in fleet sales policies of Ford F that reduced sales in 2015.

Morningstar senior auto analyst Dave Whiston is not panicking. He is sticking with his forecast of 16.9 million–17.1 million units for all of 2015. While good, that would represent slower growth than in 2014, when sales increased from 15.5 million units to 16.5 million units. In other words, if Whiston is right, we will be adding half as many units in 2015 as in 2014. I am in agreement with Whiston.

Last year, I panicked when I saw the low auto numbers, which, in retrospect, were really weather-related. Luckily, the auto manufacturers ignored my advice and kept producing autos at a very healthy pace last winter, properly anticipating a huge spring bounce. In addition, a higher percentage of pickups and other large vehicles means that slower unit growth will have a smaller impact on the Big Three, especially their profit levels. Light trucks carry higher price tags, have less competition, and carry higher margins.

While I am not worried about full-year auto sales, these temporarily low results for January and February will potentially make a serious dent in the consumption numbers for February. Consumption numbers for January were just OK. February is likely to be worse. This is another reason to moderate optimism about 2015 GDP growth rates. Also, this year’s slow start could slow the manufacturing sector.

Jobs Market Shows Surprising Strength
The U.S. economy added a surprisingly strong 295,000 jobs in February, according to the official Bureau of Labor Statistics report. That was well ahead of my expectations and the market’s expectation that just 240,000 jobs would be added. The growth figure was also well above the 12-month average of 275,000 jobs added.

All of this struck me as surprising because so many other reports, including weekly unemployment claims, purchasing manager employment indexes, slower GDP growth, and poor weather, all pointed to a weaker jobs report. I do caution that this may be the best jobs report we see for some time, based on those soft spots in the economy. In addition, despite seasonal adjustments, job growth has looked remarkably strong in late winter and early spring, only to fall apart over the summer months—at least that has been the trend over the past several years. The more reliable year-over-year employment growth rate has also ticked up, but not quite as drastically.

Hours worked were stable at 34.6, as they have been for the past five months. This is a pretty typical pattern in the middle of an economic recovery. In fact, sometimes those hours might be moving down modestly. Overall hourly wages increased $0.03, or about 0.1%, after a big boom last month. Year-over-year wages are up 2%. That may not seem like a lot, but with inflation hovering near zero, that modest gain will go a long way.

Sector News Is Good and Bad
The really good news is that business and professional services added 51,000 jobs. It’s great that the sector did well because those jobs have long hours and great pay. It is also the category that includes most of the office professionals who quickly come to mind when we think about quality jobs.

The private education sector, which has been under a lot of regulatory and business pressures, added 23,000 jobs after months of ho-hum performance. It was clearly one of the bigger surprises in the report. And despite some poor housing market reports lately, construction-related employment growth continued to be strong with 23,000 jobs added.

In a piece of mixed news, temporary help fell by 8,000 workers, the second monthly decline in a row. That is good news because it means that employers are feeling confident enough in their businesses to add permanent employees. Permanent assignments versus temporary ones should also encourage workers to spend more of their incomes, further boosting the economy. The bad news on the temp front is that it is a very good leading indicator of the overall employment report in the months ahead. In a strongly growing market, employers often hire temp workers because they can be added so quickly to the workforce. Therefore, the decline in temp workers is also a little worrisome.

One of the larger concerns in the report was that a lot of the employment growth, nearly 60,000 jobs, came from the restaurant industry. That is nearly double the recent average level. Unfortunately, workers in this category make low average wages and don’t work nearly as many hours as in many other categories.

As expected, some oil and gas issues are beginning to hit employment directly, as the mining sector reported job losses of 8,000 workers.

Nearing Natural Unemployment Rate
For a number of reasons, I usually don’t focus on the unemployment rate, but it was noteworthy in February as it dropped to the high end of the 5% to 5.5% range considered to be the natural, or normal, rate of unemployment. This tends to support our long-term thesis that we are approaching the point where labor market scarcities are going to become more prevalent.

This relatively low unemployment rate is also likely to make the Federal Reserve more prone to raise rates. The whole reason the Fed forced interest rates so abnormally low was to aid the employment market. That work now looks largely complete. However, with inflation rates (the other half of the Fed mandate) so low, they won’t necessarily have to rush. However, I still believe the Fed will act in 2015. Exactly which month they do the deed is still an open question.

Home Price Growth Picks Up Again
We were surprised to see home prices jump by 1.1% between December and January, according to the latest CoreLogic report. Sharply higher home prices at this point in the recovery are not necessarily a good thing for the economy. Higher prices have reduced affordability and certainly affected existing-home sales in 2014. Home prices moderated and actually fell in late 2014. We were hoping for just a little more moderation, but December provided a pretty healthy bump.

The preliminary numbers for February mercifully showed a smaller increase. However, this is just an estimate based on pending but not closed sales. In any case, the year-over-year prices are moving up again and are ever so slightly above our 4% to 5% target for all of 2015. Given that existing-home sales have been so sluggish and disappointing lately, we are a bit surprised by the sudden move up in prices. No real need to worry just yet. Perhaps it was a one-month statistical fluke.

Robert Johnson, CFA, is director of economic analysis with Morningstar.

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