Manufacturers at the Helm

This week, analysts were inundated with economic and corporate data. On balance, the news was positive, especially from the corporate sector. However, developments overseas rattled investors later in the week and caused markets to fall 1% for the week. New worries concerning debts of several southern eurozone countries, very poor new manufacturing order trends out of Germany, and continuing threats of tightening in China combined to throw a wet blanket on the world's bourses.

Meanwhile, positive news out of  Cisco (CSCO), a major bellwether for technology spending, failed to set off a rally. Even a surprise drop in the unemployment rate to 9.7% from 10.0% couldn't halt the decline.

Despite the market's concerns, I steadfastly believe that the economy will grow at a 4%-plus rate for 2010, buoyed by a resurgent manufacturing sector in the first half and better construction numbers in the second half. I will continue to monitor the world situation as well as commercial real estate markets, which remain the biggest threats to the U.S. economy.

Cisco Rings the Bell--Corporate Enthusiasm Blooms
Having been a technology analyst in another life, the highlight of the week had to be the stunningly good numbers and highly positive comments from Cisco. Management proclaimed "dramatic across-the-board acceleration and sequential improvement in our business in almost all areas."

The company is putting its money where its mouth is, too, with plans to hire 2,000-3,000 more people. Looking backward at Cisco's second fiscal quarter, both revenues ($9.8 billion vs. estimates of $9.4 billion) and earnings ($0.40 vs. estimates of $0.30) exceeded expectations.

In another tech-related tidbit, our semiconductor team notes that flash memory chips (used in cameras, jump drives, and as replacements for hard drives) may approach a shortage situation as early as the end of 2010 as a lot of capacity was shuttered in 2009 and demand is increasing.

Company news from our industrials team was equally positive with a couple of industrial capital goods suppliers,  Rockwell (ROK) and  Emerson (EMR), surprising on the upside and providing solid forecasts for the future. This is welcome news, especially given that industrial capital goods are typically one of the last areas to turn around in an economic recovery (only employment-related metrics are slower to improve). Both firms also indicated that increased production levels would require more hiring in the near future. The industrials team also reported that rail shipments were up on a year-over-year basis for the second week in a row, despite continuing weakness in coal shipments. Rail data are usually a leading indicator, but these numbers have lagged badly during this recovery.

News from the energy team was less rosy. While the overall results weren't awful, those firms with exposure to retail and refining operations fared poorly. Some of these disappointments could potentially lead to more job losses.  Royal Dutch Shell (RDS.A) announced cuts of another thousand people after some sizable layoffs in 2009.

Employment Report Reads Well, If You Take the Time
The employment report this week was very positive, though that was not the universal interpretation. The results were particularly obtuse this time, as 20,000 jobs were lost according to one part of the report, while another part said the unemployment rate dropped to 9.7% from 10.0% even as more people sought work. How is this possible?

The 20,000 job decline comes from data collected from individual business establishments. The unemployment rate, meanwhile, is calculated from surveys of individual households. Over time the two series tend to even out, but this month the more erratic household survey showed a big jump in employment and a drop in the number of unemployed.

While the small decline in the data was disappointing, it is statistically irrelevant. Ongoing hiring for the census almost ensures that we will see job growth in the next month or two. Likewise, several recent manufacturing surveys and anecdotal evidence from some of our companies seem to suggest that the hiring end of the employment situation is about to improve.

On the firing side, I've seen a little backtracking on initial unemployment claims that are now back up to 480,000 for the latest week. Holidays and large processing delays (related to low staffing levels and backlogs of pre-holiday claims) in select states seem to have messed with the numbers over the last month. Numbers at the end of December seemed unbelievably good, and more recent numbers seem worse than reality. Next week's numbers will be the first ones of the year that weren't affected by either a holiday week or by a post-holiday processing issue. I am hoping we drift back into the 450,000-460,000 range soon.

The rest of the employment report was more straightforward. Average hourly wages were up nicely (up 0.3%, or 3.6% annualized), as was the average work week. The average hourly wage is important as it gives the consumer more wherewithal to spend, and this is one of the bigger increases we have seen in some time. The average work week moved to 33.3 hours, up from its low of 33 hours. The improvement in manufacturing hours was even more dramatic. Employers often extend work weeks prior to adding more employees, so this bodes well for hiring, especially in manufacturing, during the months ahead.

In terms of sectors, manufacturing employment in January was actually up, the first positive number of this recovery and a key turning point for the economy. On a percentage basis, manufacturing has been one of the biggest losers this cycle. The temporary help sector notched another big gain at 52,000. Since bottoming this fall, the temporary help sector has added almost a quarter million jobs. Again, this is usually a precursor to real employment growth.

Retail, health-care, and the federal government were the other big gainers in January. On the other side of the coin, more than 75,000 construction jobs were lost in January--a bigger loss than in December. Weather was probably a contributing factor here, and to a lesser degree the homebuyers' credit potential expiration. The fact that job losses are being concentrated in a smaller and smaller number of industries should begin to lift consumer sentiment in the near future.

Manufacturing Bulks Up
The other big number this week was the ISM purchasing managers' report, announced on Monday. As foreshadowed by several regional reports, the nationwide index of manufacturers jumped to 58.6 from 54.9 in January. More importantly, 10 of the 12 sub-indexes were up and 13 of 18 industry groups showed expansion versus just nine a month ago.

The ISM runs correlations of its PMI index against real GDP growth. A PMI of 58.5, if it is sustained, is consistent with overall GDP growth of 5.5%--far higher than my 4% forecast. Just as important as the overall index, the employment index jumped to 53.3, marking the third month out of the last four where manufacturers had plans to expand employment.

The new orders part of the index also set a new record for this recovery at 65.9. Because it can take two or three months to fill orders, this high figure gives me some confidence that the economy won't sink back into the abyss anytime soon.

The ISM new order index was also consistent with the strong Factory Orders Report that showed orders were up about 1% in December compared with November and considerably above expectations. On a year-over-year basis, the new order index is above year-ago levels for the first time this recovery. Since current production is still down year over year, production levels will have to be stepped up to meet these new orders.

Even though manufacturing is a smaller part of the economy than it used to be, I still believe it will propel the economy forward. Manufacturing jobs generally pay better than other sectors and entail longer work weeks. Also, because things like advertising, payroll processing, and maintenance services are outsourced, I suspect that stronger manufacturing businesses will lead to stronger service sector growth in the months ahead.

Pending Home Sales End Funk
Last week was a pretty quiet one on the real estate front, although pending home sales, an early indicator of existing home sales, finally turned positive (1%) after a couple of rough months related to the uncertainty surrounding the homebuyers' credit.

Our housing analyst Eric Landry summed it all up, "Overall, we're pleased with the report, as it showed stabilization from November's federal first-time homebuyer tax-credit-induced swoon. With the credit now extended through June and rates still low by historical standards, we look for decent sales through the spring selling season."

Next week will be mercifully calm compared to this week. The notoriously hard-to-predict and not particularly useful retail sales report along with an inventory report and a midmonth consumer sentiment update are the main data items on tap. Given the recent upward creep in initial unemployment claims, Thursday's claims number takes on a little more importance than usual. A bad number isn't a deal-breaker, but I'd still like to see this number move down to the 460,000 range, and soon.

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