Thursday, June 26, 2008

Economy Slows: The Outlook

Survey results at a glance:
· Business conditions index drops below growth neutral for second time in four months.
· Prices-paid index indicates excessive inflationary pressures.
· Region lost jobs for the fourth time in five months.
· Expansions in export order prevent even more significant economic erosion.

Mid-America Leading Economic Indicator Moves Below Growth Neutral: Inflationary Pressures Remain Brisk. Inflationary pressures at the wholesale level remained high as the overall index for the Mid-America region plummeted below growth neutral for the second time in four months, according to the May Business Conditions survey of supply managers and business leaders in the nine-state region.

The Business Conditions Index, a leading economic indicator, slumped to 49.6 from April’s 55.5. Unlike the national economy, the downturn in housing and related mortgage issues have had significantly less impact here. However, record oil prices combined with soaring commodity prices have had significant and negative impacts on the businesses that we survey each month. Surging energy and commodity prices have pushed the inflation gauge to its second highest level since the survey began in 1994. The gauge, which tracks the cost of raw materials and supplies, slipped a bit to a still excessively high 92.0 from 93.1 in April. The Federal Reserve rate-setting committee meets again June 24-25. Even though the national and regional economies are clearly weak, current excessive inflationary pressures in the pipeline will force the Fed to forgo any more rate cuts for 2008.

In my judgment, excessive inflation is the most ominous problem facing the Fed and the U.S. and regional economies. The monthly employment index dropped below growth neutral for the fourth time this year with a very weak reading of 46.8 for May, down from April’s 49.0 and March’s 52.4. May’s reported job losses were in primarily in value-added services. As in previous months, expansions in exports and agriculture equipment sales pushed manufacturing job growth into positive territory for the month. Looking ahead six months, supply managers’ economic optimism, captured by the confidence index, advanced to a still weak 38.2 from April’s record low 29.4. The regional economic outlook has been undermined by the national downturn in housing, the subprime mortgage crisis and especially by record oil and gasoline prices.

Opportunities (The Bullish News)
ü Pending home sales unexpectedly increased in April to the highest reading since October, an industry group said Monday, but they remain more than 13 percent below a year ago.

ü The core producer price index, which strips out often volatile food and energy prices, rose by a mild 0.2% for May.

Threats/The Bad News (Dangers)
o Retail gas prices rose further above a national average of $4 Monday, and are likely to keep rising as distributors and retailers hike prices in response to last week's unprecedented oil price rally.

o Estimates of U.S. retail and food services sales for April, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $378.1 billion, a decrease of 0.2% from the previous month and 2.0% above April 2007. Gasoline station sales were up 16.3% from April 2007 and sales of food and beverage stores were up 5.7% from last year.

o The upward swing in crude oil prices began Thursday, after European Central Bank President Jean-Claude Trichet suggested the bank could increase interest rates in July to counter rising inflation.

o The unemployment rate surged to 5.5% in May from 5%, the largest monthly spike in more than two decades, as the economy shed 49,000 jobs for a fifth month of decline.Skip to next paragraph More than 1.55 million Americans have been out of work for more than six months — 200,000 more than in March 2002, several months after the past recession ended.

o U.S. manufacturing activity contracted for the fourth consecutive month in May, with price pressures again intensifying, according to ISM report.

o Initial claims for state unemployment benefits rose modestly last week as the number of continuing claims stayed at a level not seen in four years, the Labor Department reported Thursday. Rising 4,000 to 372,000 in the week ended May 24, first-time claims are still in the range that suggests a weak labor market. A year ago, initial claims were at 310,000.

o The Labor Department said its index of producer prices jumped 1.4% in May - the largest increase since November and an indication that companies are having to swallow large cost increases.
The Outlook
· I expect the Fed to make no changes to interest rates at it next meetings on June 24/25. In fact, I two voting members to ask for a rate hike with the remainder voting to hold rates where they are.

· From the latest National Association of Business Economics survey:
o Almost 20% of NABE panelists expect inflation-adjusted gross domestic product (real GDP) to grow at an annual rate above 1% in the first half of 2008. Thirty percent of respondents expect real GDP growth to be negative.
o Weakening market conditions and soaring commodity prices are squeezing profit margins. For the first time since the spring of 2003, reports of falling profit margins (28% of respondents) outnumbered reports of rising margins (18%).
o Tight credit market conditions appear to be having a larger impact on the economy compared with the January survey. Thirty-nine percent of respondents stated that tightening credit conditions have negatively affected their business, up from 26% in January.
o Capital spending plans for the coming year pulled back in the most recent survey. This decline was spread across all sectors, especially in services. Expectations decreased for computer and communications equipment outlays and for structures investment, with the services sector reporting the largest declines in plans. Only 8% of respondents said they would add or accelerate investment as a result of depreciation provisions of the stimulus bill.
o Skilled labor remains the only major input that is in short supply. Some 38% of firms reported a shortage of skilled labor, little changed from the quarterly surveys of the past two years.
o But only 34% of respondents, far fewer than in January, expect to be able to raise prices in the coming quarter, while 13% of respondents expect to cut prices.

What to Watch For
The June PMI. Thus we will be closely watching regional and national ISM reports (July 1st and ). An index above 50.0 would be a shot in the arm but I don’t think it is going to happen. Another drop will be viewed negatively.
Retail trade for June. Released by the Census Bureau ( on July 13th, this release will be watched closely to determine if the U.S. consumer continues to pullback in buying.

The yield on the 10-year U.S. Treasury. The steepening yield curve (10 year – 2 year) should be watched closely. It is signaling two things: 1) higher expected inflation and 2) Foreigners dis-investing in U.S. long bonds.

The employment report for June released on July 3rd. Job losses for a sixth straight month will not be good for the equity market especially if the unemployment rises again. Losses above 100,000 for the month be very bad! (

First time claims for unemployment insurance. Released every Thursday. Numbers below 360,000 will be viewed positively. Remember this comes from a population, not a sample, so a lot of weight is placed on it. Readings above 375,000 will erode equity markets.

. Purchasing Job Market (send me your listings
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Supply Managers’ Reading Room.
“How buyers Survive,” Purchasing 137, no. 4 (Apr 10, 2008): p. 32-35. Purchasing professionals are trying to save dollars by hedging the energy market, becoming off-peak rate payers and locking-in advantageous prices. They have no choice with crude oil, natural gas and electricity selling at new record highs. Global industrial conglomerate Eaton is working with an energy management partner. Kennametal, a worldwide metalworking and tool production company, is working with a third-party energy provider. Electric heating products firm Marley Engineered Products has been working to pull energy purchasing away from facilities managers. Regional commercial food products producer Michael Foods required buyers to become energy commodity experts to keep up with supply, demand and pricing trends. What's the common denominator? The purchasing and supply chain managers at these and other companies are making it a priority to try to manage the buy and reduce the price paid for energy, which has gone from an overhead fixed-cost item to an erratic yet expanding drain on the bottom line. Eaton's Terry Wahlgren says that users of energy can no longer sit on the sidelines as rate takers, or as rate payers, so we have challenged our buyers and our energy-management partners to find the lowest cost at the least associated risks so we can reduce the $150 million electricity and natural gas buy 5% every year. Of course, it takes certain skills to do that, skills that are not usually on the resumes of plant managers or facilities managers - often the people in companies charged with buying energy. Those skills reside in purchasing.

Arkansas: The state’s leading economic indicator expanded for a seventh straight month. The index, based on a monthly survey of supply managers in the state, advanced to a regional high of 61.7 from 58.5 in April and 56.9 in March. Components of the overall index for May were new orders at 63.2, production at 60.5, delivery lead time at 78.9, inventories at 52.6, and employment at 52.6. Manufacturing firms in the state with a strong international presence continue to report growth with new export orders for May coming in at a very strong 70.8. On the other hand, growth was much less robust for manufacturing firms dependent on domestic business.
Iowa: For the first time since December of last year, Iowa’s Business Conditions Index declined. The index from a survey of supply managers in the state dipped to 56.6 from April’s 60.5. Components of the overall index for May were 55.3 for new orders, 63.2 for production, 52.8 for delivery lead time, 52.6 for employment, and 58.3 for inventories. Overall it was a good report for the state. Durable goods producers reported much stronger growth for May while non-durable goods manufacturers detailed pullbacks in economic activity for May. Growth was especially strong for agriculture machinery manufacturers for May.
Kansas: The state’s Business Conditions Index plummeted to a regional low for May. The index, a leading economic indicator from a survey of supply managers in the state, tumbled to 42.8 from 55.0 in April. Components of the overall index for May were new orders at 42.3, production at 39.8, delivery lead time at 61.1, employment at 33.3, and inventories at 44.4. Pullbacks in business activity for May for telecommunications firms and food processors were slowed the state economy for the month. On the other hand, businesses with close ties to the state’s large aircraft manufacturing industry continue to report expansions.
Minnesota: The state’s Business Conditions Index from a survey of supply managers in the state slumped to a tepid reading. The index, a leading economic indicator, slipped to 51.8 from April’s 55.1. Components of the overall index for May were new orders at 52.9, production at 51.9, delivery lead time at 58.5, inventories at 51.0, and employment at 45.2. Durable goods producers in the state reported healthy business activity for May. The cheap U.S. currency, especially against the Canadian dollar, has been an important ingredient in Minnesota’s economy and has partially offset weakness in other areas. The May new export orders index was a healthy 61.8.
Missouri: For a fourth straight month, Missouri’s Business Conditions Index slumped below growth neutral. The index, a leading economic indicator from a survey of supply managers slipped to 45.6 from 49.7 in April. Components of the overall index from the May survey were new orders at 45.4, production at 43.2, delivery lead time at 54.6, inventories at 41.4, and employment at 44.1. Durable-goods producers, especially transportation equipment and parts manufacturers and computer and electronic component producers, reported very weak business activity for May. Except for food processing firms, non-durable goods producers experienced weaker economic conditions for May.
Nebraska: The state’s Business Conditions Index slipped slightly for the month. The index, from a survey of supply managers, dipped to 50.3 from April’s tepid 51.0. Components of the overall index for May were 47.2 for new orders, 49.9 for production, 55.4 for delivery lead time, 52.8 for inventories, and 50.3 for employment. Durable goods producers, especially those with strong ties to the farm economy, such as agriculture equipment manufacturers, reported strong growth for May. On the other hand, information firms, such as publishing companies, detailed pullbacks in business activity for May and more than offset strength in other areas.
North Dakota: For a second straight month, North Dakota’s Business Conditions Index declined. The index, a leading economic indicator from a survey of supply mangers in the state, declined to a still healthy 58.5 from April’s 64.6. Components of the overall index for May were new orders at 62.5, production at 56.3, delivery lead time at 50.0, employment at 62.5, and inventories at 57.1. For the first time in several years, we are detecting a slowdown in the rapid growth we have been tracking in the state’s economy. However, North Dakota continues to benefit from a cheap U.S. dollar. The state’s May new export orders index rose to a regional high of 75.0. Both durable and non-durable goods producers reported healthy, but somewhat softer business activity for May.
Oklahoma: The Business Conditions Index for Oklahoma slipped below growth neutral for May. The index, a leading economic indicator, slumped to 49.6 from April’s 53.4. Components of the overall index for May were new orders at 50.0, production at 41.8, delivery lead time at 64.3, inventories at 50.1, and employment at 47.5. Pullbacks reported by non-durable goods manufacturers and telecommunications firms accounted for much of May’s weaker reading. Durable goods producers detailed solid growth for the month but was not sufficient to offset weakness in other areas.
South Dakota: For a second consecutive month, South Dakota’s Business Conditions Index slipped. The index, a leading economic indicator from a survey of supply managers in the state, dipped to 53.5 from April’s 53.9 and March’s 57.3. Components of the overall index for May were new orders at 42.3, production at 61.5, delivery lead time at 46.2, inventories at 69.2, and employment at 57.7. Growth in South Dakota’s economy is likely to continue to cool in the months. However, I expect it to remain positive for the next two quarters as expansions in the state’s farm economy and export growth fuel the economy.

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