Total Industrial Production rose 0.2% in August,
which was above the expected unchanged reading. It is slower than
the July increase of 0.9%, which was unrevised. The June reading
was revised down to a 0.1% increase from 0.4%. The absolute
increase is on the anemic side, but at least it was better than
expected, and the underlying details are stronger than the headline
number would suggest (not great, but better than 0.2%). Relative to
a year ago, total Industrial Production is up 3.4%. In normal
times, that would be OK, but for coming out of a deep recession, it
is anemic and is a substantial slowdown from what we were seeing
last year.
Total Industrial Production includes not only the output of the
nation's factories, but of its mines and utility power plants as
well. The production and consumption of electricity generally has
as much to do with the weather as it does with overall economic
activity. A big part of the weakness this month came from the
Utilities. This could be a Hurricane Irene effect, as millions were
left without power. Also, the heat wave in the South, particularly
in Texas and Oklahoma, was more intense in July than August, and
thus the need for air conditioning was not quite as intense.
Thus it is important to look at just how the manufacturing
sector is doing alone. It was up 0.5% in August, down from a 0.6%
increase in July (unrevised) but better than the unchanged reading
for June (revised down from a 0.2% increase). Year over year
factory output was up 3.8%. The increase this month still makes
this a very solid performance, and much better than expected
(although we don't have an official consensus expectation for
manufacturing output alone - at least it was better than I was
expecting). Part of the increase in factory output is probably due
to the easing of supply chain constraints growing out of the
disaster in Japan.
Utility output plunged by 3.0%, reversing a jump of 2.8% in July
(most likely due to the Texas Heat wave). In June, utility output
edged lower by 0.1%. Year over year Utility output is down 2.4%.
The utility number is mostly about weather, not changes in economic
activity, and can be very volatile. The manufacturing only number
is a better gauge of overall economic activity.
The third sector tracked by the report is Mining (including oil
and natural gas). The output of the nation’s mines rose by 1.2% in
August, up from a 1.1% increase in August, and up from June’s 0.5%
rise. Year over year mine output is up 5.6%. That is a very solid
performance, and reflects rising domestic oil and gas production,
largely due to the new shale plays (mostly in North Dakota for Oil
and in the Marcellus Shale of the Northeast for natural gas).
By stage of production, output of finished goods rose by 0.4%,
after a 0.9% increase in July and a 0.3% decline in June. Relative
to a year ago finished goods production is up 3.3%. Finished goods
are separated into consumer goods and business equipment, and there
is a real dichotomy between the two. Consumers are trying hard to
rebuild their balance sheets; businesses on the other hand,
especially large businesses, have extremely strong balance sheets.
That means consumers are spending less on current consumption while
paying down debt and building up savings. That is a tough thing to
do when you are unemployed, but the 90.9% of people who are working
are doing their best to get their personal fiscal houses in order.
In addition, a large part of consumer finished goods are imports,
not made here in the U.S. Output of finished consumer goods was up
0.2% in August, down from an increase of 0.9% in July but up from a
decline of 0.4% in June. Year over year, output of consumer goods
is up just 1.2%.
Business equipment output on the other hand has been
consistently strong. It rose 0.7% in August, down from an increase
of 1.1% in July but up from an increase of just 0.1% in June.
Still, a 0.7% increase for the month is very respectable. Business
equipment production is up 9.4% from a year ago. Business
investment in Equipment and Software has been one of the strongest
parts of the economy, contributing 0.55 points of the 1.00% total
growth in the economy in the second quarter, even though it makes
up just 7.33% of GDP. The first two thirds of the third quarter are
very strong in this regard, so look for investment in Equipment and
Software to be another solid contributor to growth in the third
quarter.
While I would not expect spectacular results, this data suggests
that we might see a bit of acceleration from the anemic 1.0% pace
of the second quarter. However, it is not likely to be above the
2.0% growth rate we really need to start to bring down unemployment
in any significant way.
Output of materials rose 0.1%, way down from the 0.9% rise in
July and the 0.6% increase in June. Materials output is up 3.9%
year over year. The first graph below (from
http://www.calculatedriskblog.com/) shows the long term path of
total industrial production (blue) and manufacturing only
industrial production (red). As manufacturing output is the bulk of
total output, it is not surprising that the two lines track pretty
well with each other over longer periods of time. While we are in
much better shape than we were a year ago, production is still well
below pre-recession levels. That is not particularly unusual two
years after the end of a recession. In the Great Recession it fell
much more than it had in any previous downturn. Notice however,
that the slope of both lines in this recovery is much steeper than
in previous recoveries.
![](http://www.zacks.com/images/upload_dir/1316105523.jpg)
The other side of the report is Capacity
Utilization. This is one of the most under appreciated
economic indicators out there, and one that deserves a lot more
attention and ink than it usually gets. Total capacity utilization
suffers from the same weather-related drawback as does Industrial
Production. Total Capacity Utilization was at 77.4%, in line with
expectations. However, July was revised down to 77.3% from 77.5%,
and June was revised down to 76.7% from 76.9%. Thus, it is
ambiguous whether the total industrial production actually
increased or decreased for the month. It is better than the current
read of last month, but worse than we thought last month was. The
revival of capacity utilization has been going on for over two
years now. A year ago, just 75.5% of our overall capacity was being
used, and that was up from a record low of 67.3% in June 2009.
The basic rule of thumb on total capacity utilization is that if
it gets up above 85%, the economy is booming and in severe danger
of overheating. This effectively raises a red flag at the Fed and
tells them that they need to raise short term interest rates to
cool the economy. It is also a signal to Congress that it is time
to either cut spending or raise taxes, also to cool down the
economy (Congress seldom listens to what capacity utilization is
saying, but the Fed does).
Congress now wants to do what would be appropriate at capacity
utilization levels of 85, when the actual level is less than 78.
Capacity utilization of around 80 signals a nice healthy economy;
sort of the Goldilocks level, not to hot, not to cold. The long
term average level is 80.4%. A level of 75% is usually associated
with a recession. The Great Recession was the only one on record
where it fell below 70%. Thus a 10.1 point improvement in overall
capacity utilization from the lows is highly significant and very
good news. On the other hand, we still have a long way to go for
the economy to be considered healthy.
The second graph (also from Calculated Risk) shows the path of
capacity utilization (total and manufacturing) since 1967. Note
that the previous expansion was sort of on the pathetic side when
it came to capacity utilization, barely getting over the long term
average at its peak; the previous two expansions both hit the 85%
overheating mark (the 1990s doing so on two separate occasions). It
does not signal a good economy by any stretch of the imagination,
but it also looks like fears that we were already falling back into
recession are overblown. On the other hand, these days industrial
output makes up a much smaller share of the overall economy than it
used to.
![](http://www.zacks.com/images/upload_dir/1316106001.jpg)
Given the weather influences on Utility Utilization, and thus
the total, it is important to look at how Manufacturing alone is
doing. Factory utilization rose to 75.0% from 74.7% in July, but
that was only after July was revised down from 75.0%, so it would
be equally valid to see factory utilization as being unchanged.
June was also revised down to 74.4% from 74.6%. Factory utilization
is up from 72.6% a year ago, and the cycle (and record) low of
64.4% in June 2009. That is still well below the long term average
level of 79.0%, so, as with total capacity, we still have a long
way to go on the factory utilization level.
Total capacity rose by 0.9% over the last year, but most of that
expansion came in the Mine and Utility segments. Manufacturing
capacity is up 0.4% from a year ago. Increased capacity is a
headwind for increased capacity utilization, but at the current
level it is a breeze, not a gale, particularly for manufacturing.
For most of the last two years we have seen year over year declines
in capacity, but now that is turning around. While shrinking
capacity makes it easier to use the remaining capacity at a higher
level, it is not a good sign for the economy. It represents a
permanent loss rather than a temporary idling of the country’s
economic potential.
Mines were working at 90.8% of capacity in August, up from 89.9%
in July and from 89.0% in June. A year ago they were operating at
87.7%, and the cycle low was 79.0%. We are actually now above the
long term average of 87.4% of capacity. When we are at or above the
long term average, minor fluctuations should not be a big macro
concern. Since there is a lot of operating leverage in most mining
companies, this probably means very good things for the
profitability of mining firms with big U.S. operations like
Freeport McMoRan (FCX) and Peabody
Energy (BTU). Mine capacity increased 2.0% year over year,
making the year over year increase in capacity utilization even
more impressive.
As depreciation is more than just an accounting exercise when it
comes to mining equipment, the high operating rates are also good
news for the equipment makers like Joy Global
(JOYG) and Caterpillar (CAT), although the U.S. is
a relatively small part of their overall business.
Utility utilization plunged to 78.7% from 81.2% in July and
79.4% in June. A year ago Utilities were operating at 82.8%, We are
far below the long term average utilization of 86.6%. We are
actually now below the 2009 low of 79.2%! Increasing utility
utilization faces a headwind because our power plant capacity has
actually been increasing even faster than our mine capacity, up
2.7% year over year. The sharp drop for the month though has more
to do with weather than the increase in capacity.
By stage of processing, utilization of facilities producing
crude goods (including the output of mines) rose to 88.1% from
87.6% in July and up from 87.0% in June. A year ago crude good
facilities were operating at 86.3% of capacity, and the cycle low
was 77.6%. We are now above the long term average of 86.4%.
Considering that crude goods capacity is up by 1.6%, a very solid
showing.
Utilization for primary, or semi finished goods fell to 74.4%
from 74.7% in July. While that is much better than the 72.8% level
of a year ago, and the cycle low of 64.9%, it is a very long way
from the long term average of 81.4%. Part of the year over year
increase is simply due to shrinking capacity, which was down
0.1%.
Utilization of facilities producing finished goods rose to 76.4%
from 76.0% in July and from 75.6% in June. It is up from 74.2% a
year ago, and a cycle low of 66.8%. It remains slightly below its
long term average of 77.3%, but we are getting closer.
Interestingly, our capacity to produce finished goods has actually
increased by 1.6% over the last year, so the rise in utilization
there is facing a fairly still headwind. Part of that is due to
Utilities, since electricity is considered a finished good.
Overall, this report was a fairly good one; better than it
appears at first glance. The increase in Industrial production was
better than expected, and that was in the face of a massive decline
in the utility segment. The revisions for July were more or less
neutral with capacity utilization revised down but production
unchanged. In other words the downward revision in utilization came
from an upward revision in capacity. That is a long term positive
for the economy.
The numbers for June, though, were revised lower, so it is not
advised to get too excited about this report. We are actually
starting to see increases in capacity, unlike the declines we were
seeing last year, and while that hurts capacity utilization, it is
a positive sign for the economy’s long term potential.
While the economy is recovering, it is still running at levels
far below its potential. The capacity utilization numbers can be
thought of as similar to the employment rate from physical capital,
much like the employment to population ratio is the employment rate
for human capital. Both are running well below where we want them
to be. While additional monetary stimulus would be useful at the
margin, the cost of capital is not the major issue right now; it is
lack of aggregate demand. As such, additional fiscal stimulus would
be much more effective in getting the economy going again.
Unfortunately, the debate in DC has nothing to do with getting
the economy going faster; it is all about the short term budget
deficit. The latest Obama proposal would be useful in getting the
economy going by raising the after tax incomes of the vast majority
of workers, and thus raising total demand. If it is not passed,
after tax incomes for the median worker will fall by about $1,000,
further slowing the economy. That would be pennywise and pound
foolish in the extreme.
Getting the economy back into high gear would also start to
raise tax revenues, and so the net cost of additional stimulus
should be less than the advertised amount. The tax
increases/deduction eliminations to pay for the program will offset
some, but hardly all, of the positive impact of the program. Big
cuts in spending now, as many in Congress are demanding, will slow
the economy significantly to the tune of hundreds of thousands
fewer jobs being created this year and in 2012. That means fewer
people without income, and hence fewer people paying income
taxes.
We have been seeing anti-stimulus from the State and Local level
throughout the Great Recession, and it is the total amount of
fiscal stimulus that counts for the economy, not just what happens
at the Federal level. De-stimulus from the lower levels of
government has offset about half of the Federal Stimulus we got
from the ARRA. The main stimulus from both QE2 and last December’s
tax deal will wear off at the end of 2011. Industrial Production
and Capacity Utilization rebounded strongly while the ARRA funds
were going out. With fiscal policy on the verge of turning deeply
concretionary, there is a very good chance that they will start to
fall again. Deep spending cuts don’t just kill jobs, they also idle
physical capacity as well.
The attempt to cut spending now is deeply misguided. The U.K.
has gone down that path, and the net result was that its economy
fell by 0.5% in the fourth quarter and only grew by 0.5% in the
first quarter and by 0.2% in the second quarter, far below the U.S.
growth rate. China took the most simulative fiscal path after the
financial meltdown, and now it is concerned about its economy
overheating. We have taken a moderately simulative path with
overall fiscal policy (stimulus at the Federal Level offset by
austerity at the State and Local level) and grew by 2.3% in the
fourth quarter and just 0.4% in the first, rebounding ever so
slightly to 1.0% growth in the second quarter.
Budget cuts that end up slowing the overall growth of the
economy will slow the recovery in tax revenues and will result in
much less progress on cutting the deficit than is advertised. As a
general rule of thumb (a.k.a. Okun's law), we need real GDP growth
of over 2.0% to see unemployment fall significantly. We might get
above that level in the second half, but not much and not for sure.
We should see some pick up in growth in the second half, as some of
the temporary headwinds fade, such as the surge in oil prices and
the effects of the Japanese Tsunami. However, massive fiscal
contraction could be a major new headwind that will keep growth sub
par, and the unemployment high and possibly even rising.
While the effects of the actual Japanese Tsunami are fading,
there is a potential figurative Tsunami coming from Europe as the
Euro project seems to be in its death throes. The disruption
potential from that is huge. Unless Europe can move towards fiscal
integration in a big way, the demise of the Euro seems inevitable,
but the timing is an open question. The political obstacles of
fiscal integration in Europe are massive, and I don’t think they
will happen. While I would like to see the project succeed as it
would make another major European war almost impossible, and would
lead to greater long term prosperity, I doubt that it will happen.
On the other hand, the short term damage done from trying to
unscramble the Euro egg could be massive, so those 17 countries may
have no choice.
PEABODY ENERGY (BTU): Free Stock Analysis Report
CATERPILLAR INC (CAT): Free Stock Analysis Report
FREEPT MC COP-B (FCX): Free Stock Analysis Report
JOY GLOBAL INC (JOYG): Free Stock Analysis Report
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