Monday, 5 July 2010

US manufacturing recovery may be about to end

The United States economic recovery is becoming increasingly at risk as signs of slower manufacturing activity continue to accumulate.

On Friday, the Labor Department reported that the economy lost 125,000 jobs in June. The underlying employment situation is somewhat better though. Excluding the 225,000 temporary census workers, employment increased 100,000.

Still, manufacturing payrolls increased by just 9,000 in June. This is the smallest gain this year.

However, employment is at best a coincident indicator. Leading indicators tell an even more worrisome story.

Also on Friday, the Economic Cycle Research Institute reported that its Weekly Leading Index fell to 122.2 in the week ending 25 June from 122.9 the week before. The annualised growth rate of the index fell to minus 7.7 percent from minus 6.9 percent the week before.

Another report on Friday by the Commerce Department showed that manufacturing orders fell 1.4 percent in May, the biggest decline since March 2009. Slower manufacturing growth would be consistent with the slower growth in manufacturing employment reported by the Labor Department.

Corroborating evidence for slowing manufacturing activity came earlier last week from the Institute for Supply Management's report on manufacturing purchasing managers. The report showed that the manufacturing PMI fell to 56.2 in June from 59.7 in May, the second consecutive month of decline. The ISM's new orders index fell to 58.5 from 65.7.

The PMI remains above 50, which is generally considered to be the dividing line between expansion and contraction in manufacturing activity, so the June reading is probably indicating only slower growth.

However, John Hussman's article "Recession Warning" on 28 June showed that the growth rate of the ECRI's WLI has historically correlated strongly with the PMI. Hussman says in his article that the WLI growth rate has a lead time of about 13 weeks over the PMI.

Therefore, the recent decline in the former indicates that the PMI is also likely to deteriorate further. The WLI growth rate had been over 20 percent in January and was still at 12 percent at the beginning of May. It is now down to minus 7.7 percent. The big falls in the PMI appear to be ahead of us.

In fact, the decline in the WLI growth rate over the past few months has been so sharp that there appears to me to be a good chance that the PMI might fall below 50 within the next few months, indicating an outright contraction in manufacturing activity.

Considering that manufacturing has been a key driver of the recovery so far, a contraction in manufacturing activity would put the economy at risk of falling back into recession.

Indeed, in his article, Hussman goes on to say that because of other conditions already prevailing, including the behaviour of the yield curve, credit spreads, stock prices, and employment growth, "the US economy is most probably either in, or immediately entering a second phase of contraction".

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