From Seoul to San Francisco, manufacturing sentiment has recovered quickly from the sudden shock of the global recession last year, when world trade stopped dead and unsold stock piled up in warehouses across the world.
Around the world, manufacturers are reporting rising output, falling stocks of finished goods and are encouraging new orders as the recovery appears to gain momentum. They were strongest in Asia, where economists said the PMI figures were consistent with pre-crisis growth rates, but also reached multi-year highs in France, the UK and the US. The JPMorgan global composite purchasing managers? index (PMI) rose to 54.4, up from 53 in September, the highest value since July 2004.
However, the improvement in sentiment, as seen in various purchasing manager indices around the world, needs to be seen in the context of last year?s collapse in purchasing of consumer durables and capital goods.
In India, IIP is up 9.1% for September 2009, reflecting persistent acceleration of consumer durables. We need to, however, take the low base effect into consideration before getting euphoric about India?s IIP numbers. The economic stimulus in the form of reduced export duty has been helpful; however, the main contributor is Sixth Pay Commission payouts, which are now beginning to spread through state governments and other components of the public sector, and are being spent by the beneficiaries. On the flip side, they are contributing to widening the already high government fiscal deficit and could cause structural damage.
On the other hand, in the UK, where official data showed the economy still contracting in the third quarter, the equivalent index leapt from 49.9 in September to 53.7 in October, the third highest monthly rise on record. However, there is uncertainty over the relationship between the business surveys and official data after the combined PMIs pointed to growth in the third quarter, while the preliminary estimate from the Office for National Statistics suggested GDP shrank by 0.4%.
In the US, the Institute for Supply Management?s factory index rose to 55.7 from 52.6 in September. US manufacturers? reported activity was at its highest level since April 2006, seemingly confirming that recent official data showing gross domestic product returned to growth in the third quarter was not just a flash in the pan. If the PMI for GDP is annualised, it corresponds to a 4.5% increase in real GDP annually.
The US Commerce Department?s report indicates that GDP rose by 3.5% in the third quarter of 2009, representing the first quarter of growth in over a year. These facts, combined with the widely accepted principle that two consecutive quarters of negative GDP growth constitutes a recession and that this recession featured one of the sharpest quarterly drops in quarter of a century, indicate that the recession appears to be over and that it was a relatively long and painful one.
However, ISM?s Report on Business seems to say that it wasn?t so bad and the recession ended a while ago.
The chart below shows GDP and ISM?s half-baked PMI-to-GDP correlation. If you look at the first circled quarter of datapoints, the GDP indicates that the economy was shrinking. The ISM says that it was growing!
The second circled quarter of datapoints indicates that while the GDP was still shrinking, ISM said that it resumed growth.
If we look between the circles, GDP shows a pretty severe decline, while ISM?s decline is much more shallow.
All in all, the GDP data indicates that the US was in a recession for at least a year. ISM, on the other hand, said that the recession was a mere 7 months long.
In every manufacturing report on business is a statement that says: ?The PMI… corresponds to an X% increase/decrease in real GDP annually.? And as can be seen from the chart, ISM?s PMI does not correspond to change in GDP! The two circled segments indicate that ISM wasn?t even directionally accurate in two of four consecutive quarters!
Now let?s take China!
China?s industrial production and retail sales accelerated in October, bolstering forecasts for economic growth to exceed 10% this quarter for the first time in more than a year. Production rose 16.1% from a year earlier, the most since March 2008. Retail sales gained an annual 16.2%
in October, and urban fixed-asset investment climbed 33.1% in the first 10 months of this year.
Evidence of accelerating retail sales or fixed-asset investment might be taken at face value elsewhere, but these are two of China?s least reliable indicators. Seasoned China-watchers accept that not everything adds up in China?s data-gathering business. The total of first-half gross domestic product figures released individually by China?s 31 provinces and municipalities, for example, was almost 10% higher than the national figure put out by the National Bureau of Statistics.
A 33.1% year-on-year rise in urban fixed-asset investment, as reported by the NBS, does not necessarily mean that investment rose by 33.1%. In China, ?investment? by Central government planners is counted on the basis of funds disbursed for projects, regardless of whether those funds have actually been spent. Similarly, retail sales figures?up 16.2%?are not a useful proxy for household consumption as they basically track shipments to retailers, lumping in all kinds of government and corporate spending.
The problem with counting money transfers as investment, or mixing up institutional spending with consumer, is that there may be big lags in the impact of stimulus efforts. That is as good an explanation as any for China?s continuing reluctance to tighten monetary conditions explicitly, amid mounting evidence of asset inflation: urban property prices were up almost 4% in October, the biggest monthly increase in 14 months.
The world?s manufacturing renaissance, though, raises the risk that if companies fail to find end buyers for their rebuilt inventories, they will cut back fast, triggering a double-dip recession in the first quarter of 2010.
A closer look at the US Institute of Supply Management Survey shows that the employment index expanded for the first time in over a year. Thus far, employment had remained below the key 50% mark that indicates confidence. The US has seen job shedding at a rate not experienced elsewhere and this boost to the labour market came a few days before US unemployment officially crossed the symbolically important 10% level.
Besides, the broader picture of the economy is not reflected in manufacturing indices because it does not take into consideration services, which are important parts of payrolls and employment data that has continued to falter.
However, employment is a lagging indicator. A leading indicator in the survey are new orders. New orders continue to improve but the pace of improvement is slowing, raising doubts over durability of recent inventory rebuilding that has fuelled growth.
Manufacturing indices focus on the biggest companies and ignore the small manufacturing companies, whose sentiment?out later in the month?has sharply lagged behind that of the bigger ones. That can pull down employment and growth. The continued decline in bank lending?the Federal Reserve last week said loans and leases at commercial banks fell for a 21st consecutive week ?and the bankruptcy of commercial US lender CIT Group, shows the difficulty smaller groups have in obtaining credit. This can keep growth low.
The strength in the ISM numbers, though, raises the risk that if companies fail to find end buyers for their rebuilt inventories, they will cut back fast, triggering a double-dip recession in the first quarter of 2010.
As can be clearly seen in the chart, the disposable personal income in the US fell in Q3 2009; however, the personal consumption expenditure rose (that is, Americans spent beyond their means) and expenditure on durable goods also rose dramatically, thanks to the generous cash-for-clunkers programme of the US government.
This is not a sustainable trend, until unemployment falls. Although initial jobless claims continue to fall, unemployment is still at a historical high, making the current jobless recovery look extremely fragile. The unemployment rate in the US has hit 10.2%, topping the 10% mark for the first time since June 1983. Back in September 1982 when the unemployment rate moved above 10% for the first time in the post-WW II era, the rate remained above 10% for 10 months and hit a peak of 10.8% in November and December of 1982.
Whether or not central banks around the world are interpreting the manufacturing data in the same way as the markets will be crucial in determining growth in the months ahead.
?The author is a Wharton Business School MBA, and CEO, Global Money Investor
