Signs of Life in Manufacturing

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Manufacturing and housing have been two sectors of the economy that we've been keeping a close eye on. I'm here with Bob Johnson--he is our director of economic analysis--to look at some recent data and to see the state of these two sectors.

Bob, thanks for joining me.

Bob Johnson: Thanks for having me today.

Glaser: Let's start with manufacturing. We saw the orders for durable goods. The headline number on that was down at least. Does that make you somewhat pessimistic about what's happening in the manufacturing sector?

Johnson: No. As a matter of fact, it was one of the best durable-goods manufacturing reports I've seen in some time. You are absolutely correct that the headline number showed orders were down 0.5%. But when you include that very volatile transportation sector, orders were actually up 0.5%, marking the second month in a row of improvement.

Glaser: And why does it make sense to throw transportation out?

Johnson: Transportation is a relatively large sector in the report. But the reason we toss it out is particularly because of the airliners, which are very long lead items. You can place an order today and you may not receive that jet until 2019, and that's when it's going to actually move the economy. And it depends on when the airshows are, when the new models come out, and about how the orders flow. So, they're really not telling us about the state of the economy.

We like to look at new orders because it tells us what's going to ship in the months ahead. Durable-goods orders tend not to ship right away. They tend to ship further out in time, so they are a great leading indicator. Unfortunately, with airliners, it's a little bit too long at 10 years.

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Glaser: So, when we're looking at new orders, then, what is it telling you about the state of the manufacturing economy?

Johnson: We had a really soft spell in manufacturing. We've seen it in industrial production, we've seen it in the ISM Purchasing Managers numbers. However you want to look at it, it's been a tough go for manufacturing. And in this particular index--the durable-goods orders, excluding transportation--we were down five months in a row between October and February. Five straight months of decline. So, certainly, that was not a very good period for the manufacturing sector. And we averaged about a 0.6% decline in each and every one of those months. So, that's a pretty big decline that we saw there. And now, like I said, we've had two good months--unfortunately not yet enough to offset the whole decline that we've seen since October.

Glaser: So, that's maybe a sign that we've hit a bottom there. Why should investors--or people just generally--care about what's happening in the manufacturing economy? Does this really move the needle?

Johnson: Depending on what metric you use, it's 8% to 10% of our employment, and it's a highly productive segment, so it helps GDP a lot. So, it's always good to see the manufacturing sector do well, and obviously there are good-paying jobs as well. So certainly, it's a sector that we love to see do well, and we've hated having to warn for the last year about the softness in that sector. But [things are finally looking up]. I don't think we're going to get really robust numbers, but I certainly think we're doing better. And again, like so many things, I like to look year over year, too. And, there, orders are only up 0.7%.

So, these are really great numbers; but when you look at it year over year, we've still got a long way to go. And inventories, frankly, were growing a little faster; year over year, we're over 3% growth in inventories. So, that suggests that we shouldn't get too excited here.

Glaser: Looking at housing, we saw some data on new-home sales. I know this is a report that you're sometimes a little bit iffy on. What did we learn from that this week?

Johnson: The new-home sales is a very small and specific sector. It's only the single family. It doesn't show apartment buildings. I've always not been a huge fan because it includes sales of homes that have not even been started yet--ones where people say, "We're going to build it over there, and we're going to start in six months." It includes homes that are almost finished, where somebody says, "We're leaving it here and you get to pick out the sink and the carpeting, and then we will finish it." And there is a whole other set of homes that are completely finished, sitting on the lot, and may have been sitting there for two years. And so they're all counted in this report as new-home sales. So, it doesn't give you a good feel for what's going to happen in actual manufacturing of homes.

But on the other hand, it does give you a good feel--better than any other report--about demand for new housing, in general, because it does include that component of buyers who have bought a home off of a plan. And that home hasn't got a permit. It hasn't started. It hasn't done anything yet. The only place that's going to show up is in this report. It's a great leading indicator, and it looked very good this month.

Glaser: And how has it looked in the recent past?

Johnson: Where we are right now, we've had 500,000 or more new homes sold in three of the last four months. Prior to that, we hadn't been above 500,000 since all the way back to 2008--seven years ago. So, it's really a great recent improvement, and it seems sustainable--three out of four months. It's not like we had a one-month weather bounceback or we had a special tax credit or something that just helped for a couple months. This really appears to be a very solid long-term trend. So, that's really great news.

We're way off our bottom on this metric, by the way. We were at 517,000 this last month. We've been as low as 280,000; we've also been as high as 1.4 million. So, we've got a ways to go on the upside, but we're certainly nicely off the bottom and certainly nicely off the mid-400,000 rut that we'd been stuck in for a couple of years.

Glaser: So, if new-home sales look better, how about prices in homes?

Johnson: That's a very interesting question. Inventories had been tight. People had been unwilling to put their homes on the market. Builders had been focused on the high end a little bit on their homes and really haven't gone hog-wild building spec homes.

So, inventories are tight--and that's good news and bad news. It's bad news for a buyer because prices have gone up. We saw that prices in new-home sales were up, on a year-over-year basis, something like 6%. It was a combination of price increases and mix shift to the higher end that I talked about. So clearly, higher inventories have meant higher prices. And then we've seen data from Case-Shiller and also FHFA that both suggest that home prices of existing homes are also going up.

The number doesn't sound very dramatic. It's up about 5%, year over year, on the [S&P/Case-Shiller 20-City Composite Home Price Index]. But that's up from a low of 4.3%, so that's trending up. And again, we use that year-over-year methodology, so if some of those lower yields begin to peel off, we'll see the impact of what have been some pretty strong months for home prices. In the last couple of months, we've seen home prices up 1%, month to month, which obviously annualizes to something closer to 12%. I don't think we're anywhere near there. Trust me--when we get to the fall, we will slide back a little bit, even though those are seasonally adjusted. But it looks like if I had said 4% to 6% home appreciation for the year, it certainly looks like we're going to be closer to 6% than to 4% by the time we get to the end of the year.

Glaser: So, some reasonably good news coming out of the housing market?

Johnson: Absolutely. Great new-home sales combined with very attractive financing options out there still and some fear that the rates will be going up shortly. So, it's gotten people to move a little bit more into action. I think that's all been great news for housing. Unfortunately, all of the activity has pushed prices up, which will certainly affect affordability.

Glaser: Bob, thanks for your thoughts today.

Johnson: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.