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Factory Sector Recession Is Confirmed

Wed, Oct 1 2008, 22:42 GMT
by Asha Bangalore

Northern Trust

Factory Sector Recession Is Confirmed

The ISM manufacturing composite index fell to 43.5 in September from 49.9 in August. With the exception of two occurrences, all post-war recessions are associated with readings similar to the level of the September 2008 composite ISM manufacturing index.

Indexes tracking new orders (38.3 vs. 48.3 in August) and production (40.8 vs. 52.1 in August) plunged to 38.8 in September, another piece of evidence confirming weak fundamentals of the factory sector. In the Blue Chip Financial Forecasts for October 2008, 29.7% of the respondents indicated that the U.S. economy is not in a recession/will not enter a recession in 2008. Maybe they will revise their opinion after today’s factory survey.

Indexes tracking employment, backlogs, exports, inventories, and imports declined in September. Charts 1 and 2 say it better than words can depict the situation. The factory sector is in the midst of a serious slump.

Auto Sales Post Sharp Decline in September

Auto sales fell to an annual rate of 12.5 million units in September from 13.7 million in August. In the third quarter, auto sales have sold at an annual rate of 12.92 million units, down from 14.2 million in the second quarter. This is the slowest pace of auto sales since third quarter of 1992 (see chart 3). Auto sales fell at an annual rate of 30.6% in the third quarter, marking the fifth quarterly decline in the last six quarters. Given the weakness in consumer spending in July and August and projected softness in September, it is most likely that inflation adjusted consumer spending will post the first quarterly decline since the fourth quarter of 1991, which raises the probability of a contraction of real GDP in the third quarter.

Construction Spending Is Flat, But June and July Data Show Downward Revisions

Construction spending during August was unchanged from July. Total construction spending in June is now -0.2% vs. +0.3% in the earlier report and July outlays were revised down to -1.4% vs. -0.6% in the prior estimate. Residential construction outlays for June (-4.0% vs. -1.4% in earlier report) and July (-3.9% vs. -2.3% in the earlier estimate) show sharp downward revisions. Therefore, we will reserve our comment about the 0.3% gain in residential construction spending during August. Non-residential private sector consumer spending has dropped for two consecutive months, with the July estimate revised to -1.1% from -0.7%.

Japan: The Outlook Was Bad Even Before Lehman Brothers

Three weeks ago we commented about Japan’s weakening outlook for the second half of 2008, and our anecdotal forecast amounted to, “Q3 looks rather weak and Q4 looks abysmal”. Plenty of other analysts were also in that mindset, and not surprisingly forecast that the quarterly Tankan report on business activity would post a modestly negative number. Indeed it did, but there are two factors that give these bearish numbers a little more gravity. First, the figures even disappointed those with weak forecasts, and second, the surveys used to create the Tankan report were submitted before the news hit the wire about the Lehman Brothers collapse and the failures that followed. If people were this pessimistic before this financial crisis exploded, the post-collapse mindset must have been downright depressing.

The decline in the headline Tankan actual conditions index to -3 marks the fourth consecutive fall in this benchmark for business activity, and the venture into negative territory (for both actual and forecast activity) is quite suggestive of an approaching or ongoing recession. Along with the business conditions indexes came the outlook for capital spending over the next six months, which is predicted to only rise by 1.7% compared with the 2.4% figure posted in the Q2 survey (the consensus figured on another 2.4% reading). So apparently, big companies had already been thinking about trimming expansion plans in Q3 – before Lehman went under and the credit markets really tightened up.

At this point, we do not feel a pressing need to downgrade our economic forecast for the end of the year – a Q4 reading of ‘abysmal’ still seems appropriate. We also feel that the Bank of Japan will remain on the sidelines after its two-day meeting ending October 7, but it will recognize that the pending recession might have a little more depth than expected while the inflation outlook remains unchanged. The next indicators we are concerned about are the August report on private machinery orders on October 9 and the September money supply report on October 10. We expect these to reinforce the scenario of an economy that will only weaken throughout the year and into early-2009.

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Published on  Wed, Oct 1 2008, 22:46 GMT