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Local economy remains strong, but red flags are on horizon
Good news is always welcome, and according to the latest survey conducted during the last two weeks of April, the West Michigan economy is surprisingly strong.
New Orders, our index of business improvement, bounced to 35, up nicely from 21. However, the Production index remained very strong but eased to 29 from 31. Activity in the purchasing offices, the index of Purchases, came in virtually unchanged at 26. The stronger April sales reports pulled the Finished Goods Inventories index down to minus 4. The fear of more price increases probably helped drive the Raw Materials Inventories index up to 16 from 9. Overall, the second quarter of 2017 has begun on a strong note.
Looking at individual industries, most auto parts suppliers still are positive, although several respondents have voiced concerns about softening auto sales. The office furniture business still is experiencing a spring rally, and smaller firms are outpacing their larger counterparts. The capital equipment market has turned mixed, but the bias is to the up side. Just like for the past several months, the performance for the industrial distributors continues to be mixed.
There now are some apparent signs the Trump rally may be running out of steam. For April, our West Michigan index of the Short Term Business Outlook, which asks local firms about the perception for the next three to six months, remained positive but backtracked to 32 from 37. Looking out three to five years, the Long Term Business Outlook also remained positive but edged down to a near-record low of 35 from 47.
The May 1 report from the Institute for Supply Management, our parent organization, remains positive, although the pace of advancement has slowed. New Orders, ISM’S index of business improvement, eased modestly to 27 from 35. However, the Production index accelerated to 31 from 21. ISM’s index of Employment remained strong but backtracked to 11 from 16. ISM’s overall index for April eased to 54.8, down from the lofty 57.2 reported last month. At 54.8, the U.S. PMI still is strong, but not nearly as strong as the PMI reports coming from the European countries.
The April survey of the U.S. manufacturing conducted by Markit.com, the British economics consulting firm, remains positive, but less robust. New Orders moderated to the slowest pace since September 2016. The Markit PMI for the U.S. came in at 52.8, down slightly from 53.3.
Comments from Chris Williamson, the chief business economist for Markit, continue to be cautious:
“Manufacturers reported that growth of production and order books have slowed markedly since peaking in January, with April seeing the weakest improvements for seven months. The signs of slowing growth are most evident in the domestic consumer sector, but investment goods manufacturers continue to fare well, enjoying stronger capital equipment spending from the energy sector in particular. Exports also have perked up, with April seeing the steepest increase in foreign orders for eight months. Price pressures have meanwhile risen to a two-and-a-half year high, which is likely to feed through to final prices paid for goods consumers in coming months.”
The May 2 report from the JPMorgan Global Manufacturing survey of 31 nations slowed to a three-month low. JPM’s overall index eased modestly to 52.8 from a 69-month high of 53.0. In most cases, developed nations recorded stronger rates of improvement than emerging markets. The rate of increase in new export business edged higher.
For the Eurozone, business conditions are significantly better. The latest Eurozone PMI is now up to 56.7, and survey readings indicate that manufacturing is growing at an annual rate of approximately 4 to 5 percent. The PMI for countries like Germany, Austria, Netherlands, Italy and France now are at or near six-year highs. Greece remains in the doldrums. Despite some nervousness over the upcoming French election, European business disposition remains cautiously positive.
David Hensley, the survey author, further noted:
“The start of the second quarter saw a slight loss of growth momentum in the global manufacturing sector. Rates of increase eased for both production and new orders, although the outlook remains positive given a backdrop of solid business confidence and rising backlogs of work. The continued upturn is also feeding through to the labor market, with jobs added for the eighth straight month.”
In other economic news, the Department of Commerce estimates that GDP for the first quarter of 2017 grew by only 0.7 percent. Whereas some of the weakness can be attributed to unfavorable weather throughout the south and mid-section of country, a few analysts have noted the past few years have a pattern of weak first quarter growth followed by offsetting quarters for the rest of the year. Hence, the estimates for the second quarter GDP are running as high as 4.5 percent.
For West Michigan employment, spring has again arrived. Of the 83 counties in Michigan, Ottawa County currently boasts the lowest unemployment rate of 2.8 percent, followed by 3 percent for Kent County. Kalamazoo County garnered fifth place with a rate of 3.5 percent. Because these numbers are not seasonally adjusted, at least some of the improved numbers are the result of cyclical variation. The West Michigan index of Employment came in at 25, a two-year high. All of this means many firms still are adding staff, even though there are signs that both the automotive and office furniture industries are topping out.
The current wave of industrial inflation shows no sign of subsiding anytime soon. Our local index of Prices remained at the lofty level of 38, very near a six-year high. Just as last month, not a single firm reported a significant level of falling prices, and the list of commodities climbing in price continues to grow. At the national level, ISM’s index of Prices moderated slightly to 37, down from 41. JPMorgan’s International index of Prices remains stuck at a fairly lofty 60.0.
Will the current round of industrial inflation spill over into the consumer market? Probably not.
About 50 years ago, it only took a few months before industrial inflation would be reflected in prices for most of the high-ticket consumer goods, such as appliances and automobiles. Additional inflation for other goods would quickly follow. But we experienced a similar wave of industrial inflation in early 2011, and the impact on consumer inflation was negligible. After a few months, most prices came back to normal. We simply live in a different world wherein foreign competition tends to thwart the temptation for many manufacturers to raise prices.
Unfortunately for our local auto parts suppliers, the spring year-over-year sales drop in light vehicle sales continues to accelerate. For April, there wasn’t much of any place to hide. According to the monthly posting by Automotive News, sales for Ford declined 7.1 percent, followed by a 6.6 percent drop at Fiat-Chrysler. General Motors, which had managed a small gain last month, slipped 5.8 percent in April. Among the other major brands, Honda dropped 7 percent, Nissan yielded 1.5 percent and Toyota eased 4.4 percent. Subaru bucked the trend and gained 3.9 percent. All of this resulted in a drop of 4.7 percent for the entire industry, marking the fourth consecutive monthly setback for U.S. sales and longest losing streak since the beginning of the 2009 Great Recession.
In an otherwise strong economy, why are auto sales sagging? There are several reasons. First, because of sales pressure from their parent companies, dealer inventories now have risen to a 90-day supply, well above the ideal level of 60 days. The industry analysts note light truck and crossover sales no longer are filling the gap created by sharply falling car sales. For instance, April car (non-truck or SUV) sales fell by 13 percent for GM and 21 percent for Ford. This trend clearly is not positive. Furthermore, a wave of vehicles coming off lease is now depressing the used car market as well as creating a lower cost alternative to the new car market. Even though rebates and other incentives continue to rise, the market no longer is responding like it did a few years ago. After dipping back into sub-prime lending, some of the lending institutions are starting to re-tighten their lending standards. For West Michigan, all of this means production schedules for several local firms may begin to taper.
Despite optimistic rhetoric from GM and other automotive executives about the remainder of the 2017 sales season, the fact remains market saturation finally is starting to set in. We have previously noted the current market can absorb about 15.5 million cars per year, and any excess is at the expense of future sales. The public now demands higher quality cars and trucks, and the industry has made great strides in meeting the demand. However, the down side is that high-quality cars last much longer than their counterparts of 20 years ago. Furthermore, the number of miles Americans are driving has yet to recover fully from the Great Recession.
In summary, the post-election rally may have run its course, but positive news from Washington can keep the ball rolling. Our local statistics remain strong, and at least for now, there is no sign we are sliding toward a recession. But caution flags are out. For West Michigan, we need to keep a close eye on auto sales, because slower sales eventually will spill over into reduced production schedules for an industry that has been booming since the infamous “Cash for Clunkers” incentive program of 2009. The markets still are hoping for decreased regulation and lower taxes, but progress in Washington has been slow. A significant cut in business taxes would be greeted with enthusiasm, but Washington’s deadlock could slow the growth for the last half of 2017.
Brian Long, Ph.D., is director of supply chain management research at Seidman College of Business, Grand Valley State University.