The Institute for Supply Chain Management surprised the world on Monday morning, as they announced the results of their manufacturing managers survey. The report is essentially a survey where every manager is asked to respond to his own experience. Each manager states whether they see conditions improving, deteriorating or remaining constant, with respect to thirteen main criteria. The December survey's headline number at 55.9%, tells us that when all criteria responses were averaged, that 55.9% of respondents saw conditions as favorable.
The consumption of manufactured goods represented 1.59% of the revised 2.2% U.S. GDP growth in Q3 2009 and thus remains the center point of the economic recovery as we have known it thus far. The growth indicative ISM report booned U.S. markets in the first 2010 trading session, as the seemingly unbeatable 60.3 November New Orders component was crushed by a 65.5 stat in December. New Orders are the single most telling economic reading of future conditions in Manufacturing, perhaps making this month's strength unbeatable in January and ironically a curse on the effects of less positive results moving forward. Less discussed but also important, are increasingly slower deliver times that, if sustainable, should have positive effects on both transportation carriers' top lines and jobs in the industry.
Standing on the shoulders of a massive rally to start 2010, it is safe to say that the environment is still a wash of confusion. Inventory numbers from the report show that clients of manufacturers are becoming increasingly skeptical, where the Customers' Inventories number at 35 perpetuated a nine month trend of contraction during one of the highest consumer demand months of the year. These results suggest that inventory rebuilding hasn't occurred on par with headlines, and that instead the entire production chain has become extremely lean and risk averse. Should confidence return and consumers loosen their wallets, this would be a prime area of growth in the new year, but headwinds to such spending remain significant and could intensify. Partly frightening, is the component of higher input prices, continuing a six month trend of appreciation that is reflective of the commodity rally and U.S. Dollar weakness. While input prices have helped to raise the ISM headline number in recent months, U.S. Dollar strength will be discounted as having a negative effect on future reports.
Kicking the mud from our boots, let us shed the stats from our purview and think logically about the chances for economic success in the U.S. over the next year. 2010 estimates for U.S. GDP growth are floating in the mid 3% range, but where can we expect to find growth summing up to this handsome rate of expansion?
In the U.S. 24% of annual GDP dollars are rooted in manufactured goods, while the service industry brings in nearly twice that figure. In Q3 of 2009 we lost about 3% to our trade deficit, which should grow if consumers spend more, and the remaining 30% is split into one part domestic investment, two parts government expenditures. We can expect that the government isn't going to muster much more growth in 2010, due to it's bureaucratic inefficiencies and the Q3 2009 0.5% annual contributed GDP growth, despite $700 billion (5.3% x GDP) of stimulus.
For all intensive purposes we are left with the manufacturing and service industries to get us most of the way to 3% growth. "We did it in 2003, so it's just a matter of animal spirits... right?" Unfortunately, in our opinion, the game has changed significantly, making 2009 anything but 2003. First, there is not an abundant supply of new homes, and the supply we have aren't being bought, so the big new houses of Super Sized Suburbia30 miles from town won't have the same magnetic effects on consumption as were present in 2003-2006. Instead we're seeing strength in existing home sales and less confident builders realizing that bigger isn't better. Second, unemployment is expected to average 10% in 2010, according to Bloomberg economists, landing well above the worst case scenario for financial institutions outlined under the Stress Tests in April of 2009 and crippling to the financial strength of the government, as Washington continues to roll over benefits and pay to jobless individual. Third, the shadow inventory of homes, as described by Robert Shiller, will flood the market with more defaults as teaser rates reset higher, even as rates are low, while weakening bonds will inevitably send mortgage rates higher.
Some of the smartest guys in the room are beginning to make calls that hold viral ramifications for the economy. Robert Shiller is predicting higher rates of defaults in the prime mortgage category, while Bill Gross is liquidating most of his exposure to bonds, and still many see this scenario as a victory on il-applied grounds of historical market recoveries. Perhaps confident retailers and mid-chain distributors could lift inventory levels as consumers spend more of what they've saved, but there must be widespread consumer spending on services as well as goods, at magnitudes congruent with a boisterous labor market, for 3% GDP to become a reality. At minimal, do your homework before placing your bets on a recovery founded in manufacturing, and at best keep limber to capitalize on the self fulfilling prophecy that equity markets have become when sentiment changes yet again.
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