Manufacturing Sector Enters Early Consolidation Phase
Is the long-lost (or at least hidden) business cycle in the US economic data finally returning?
Some version of this question has vexed economists and market analysts and politicians for most of the past decade. Perhaps you have heard it expressed as, “Where are we in this cycle? Mid or Late?”
To this day, there is a wide range of informed opinions on just where we are in the cycle, and I find it interesting that when these opinions are discussed they often require some knowledge of baseball in order to interpret them--“We are in the sixth (or third, or ninth, or even tenth) inning of this cycle.”
I have no doubt that most people in the manufacturing sector enjoy a good baseball reference. But understanding just where we are in the cycle is how owners and executives in this business make decisions about investing in new equipment or hiring new workers. It’s a little more important than a game to them.
Nevertheless, the always-challenging task of analyzing and forecasting the business cycle has been more difficult than usual in recent years. The Great Recession resulted in a staggering disruption to the US economy, and it has taken much longer than anyone ever expected to recover. There are still some segments that have not recovered, and all of this has put some big wrinkles in the cycle patterns. But I am starting to think that just maybe the classic cyclical pattern in the manufacturing data is re-emerging.
The chart shows the twelve-month rate-of-change graphs derived from the monthly new orders data for both durable goods and nondurable goods in the US. The cyclical patterns of these sectors have historically varied in predictable ways. For instance, the durable goods graph is usually more volatile. The conventional wisdom has always been that durable goods are more expensive than nondurables.
Another difference is that financing is often used for the purchase of many types of durable goods. Therefore, these markets are highly sensitive to changes in both incomes and interest rates. Thus, the rate-of-change graph should be higher at the peaks and deeper at the troughs. This is easily seen during the last recession in 2009 and the first year of the recovery in 2010.
Nondurables are mostly consumer staples: energy, food, and clothing. These categories are usually less sensitive to changes in incomes and interest rates. But the conventional wisdom did not hold during the cyclical trough in 2015 when interest rates were extremely low.
I could fill up a lot of pages describing how these two graphs and the whole US economy failed to perform in the “usual” manner during the past ten years, and I have no doubt this will be the subject of numerous books and case studies in the future. But my immediate interest is the chart pattern of the past three or four years. Specifically, it is starting to look kind of “normal” again.
To be sure, the latest cycle is longer and less volatile than most of the cycles of the past, but the pattern is undeniably familiar. If this a return to normal, then the four letters on the chart mark the four major phases of the latest business cycle:
A – early recovery/expansion
B – late recovery/expansion
C – early consolidation/contraction
D – late consolidation/contraction
These areas are defined by the high and low points on the graph. Another important consideration is whether the graph is above or below the zero-line. If the graph is above the zero-line it means that total new orders for the past twelve months have expanded when compared with the previous twelve months. A graph below the zero-line indicates that new orders in the most recent twelve months have contracted when compared with the same period of a year earlier.
It is worth noting that a cyclical peak need not get above the zero-line. This is what happens in an industry that is suffering a secular decline. And a cyclical trough need not fall below the zero-line, which often happens in a new, disruptive industry that is experiencing rapid growth. Most of the important end markets for plastics products are dominated by mature industries, and their cyclical patterns will mostly resemble that of the overall economy.
If we are returning to a more typical cyclical pattern, then the graph clearly indicates we are currently in a period of early consolidation or recession.
This means the actual monthly data is declining. In the second quarter of 2019, new orders of durable goods decreased two percent when compared with the same period of 2018. For the year to date total, the growth in orders for durable goods is still positive, but just barely. I expect the gradual decline to continue for the next few quarters. This will result in a decline in the annual total for new orders of durable goods in 2019 of two to three percent.
The pattern in the graph for nondurables is similar, but the actual numbers are not quite as negative. In the second quarter of this year, new orders of nondurables increased by less than one percent. For the year to date, orders of nondurables are also up by less than one percent. The trajectory in this graph will continue to aim downward, and the annual decline this year will also be a modest one percent.
And whether you are an executive in the manufacturing sector, or a candidate for President of the United States, all of this begs the question, “When and where will the graph hit the next low-point?”
My current prediction is the next troughs in these graphs will occur in the first half of 2020, and the declines will be shallow. The low points for both graphs should stay above negative five percent. The US is currently enjoying solid growth in consumer incomes and spending, and 2020 is an election year. These factors will buoy the new orders data.
The downward pressure on the data appears to be the result of recent foreign trade policy, and this could get much better or much worse in the coming year. Stay tuned.
