Commencement 2014: Avoid the Noise

As Elon Musk advised graduates recently, focus on signal over noise. Growth will slow, but now is the time for aggressive planning and preparation.

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Elon Musk, CEO of Tesla Motors and SpaceX, knows something about perseverance and single-minded focus against challenging odds. He made a fortune, lost it, and now is making another. One piece of advice he had for this year’s USC Marshall School graduates: “Focus on signal over noise. A lot of companies get confused; they spend money on things that don’t actually make the product better.”

We spend no time at ITR perusing the daily headlines for trends. News cycles wax and wane. What is reported is often a snapshot, month-to-month data—in other words, today’s noise. Mistaking today’s headlines as a trend can lead to confusion, indecision and even costly mistakes.

After stumbling into the first quarter of 2014 (GDP -2.1 percent), the Federal Reserve Board (FRB) quickly lowered its 2014 forecast by more than half a percentage point, from 2.8 percent to 2.1 percent (annualized). The preliminary second-quarter GDP estimate rose a sharp 4.2 percent. Even the FRB can be caught in statistical noise. Where is the U.S. economy is headed? Here is what the leading indicator signals and ITR’s analysis are saying about the next few years: Growth is in your future.

The U.S. Industrial Production Index (manufacturing, mining, utilities), ITR’s benchmark for determining where the U.S. economy is in the current business cycle, is at a record high. Annual growth of 3.6 percent is above the 30-year average of about 2.2 percent. The internal trends indicate additional rise into 2015.

Total capacity utilization, at 79.1 percent, is a mere 0.5 percent below the historic average. Capacity utilization is often seen as a precursor to supply constraints, inflationary pressures and increased investment in capital equipment.

One point of inflation in the technology world is competitive wages (benefits) sufficient to retain valuable employees. Don’t lose key employees to competitors. Also, be sure you have enough capital and a healthy supply chain to meet increasing activity.

Manufacturing, 71.3 percent of the index, is growing at a solid 3.2 percent pace (annual basis) on strong production in nonmetallic minerals, auto and aerospace, business equipment, electronics, and fabricated and primary metal products. The growth in manufacturing pushed manufacturing construction to a four-year high ($48.8 billion) and heading higher. Annual chemical production is at a 63-month high. Abundant feedstock and energy from natural gas has juiced annual private construction of chemical plants to a record $17.9 billion, 39.3 percent above last year and soaring. Food production inched higher in July. The strongest sector is the record-setting animal food production, up 10.6 percent over a year ago. Annual civilian aircraft equipment production is the highest it’s been in six years. North American automakers produced 16.6 million cars, the highest since 2001.

Business confidence, as reported by the July Purchasing Managers Index (ISM), hit a three-year high (57.1), with 17 of the 18 sectors reporting growth. The July ITR Leading Indicator, which leads the overall U.S. economy by 11 months (median), is off the 2013 apex, but is still a healthy 4.1 percent above last year. These signals point to increasing activity in the general economy.

Oil and gas production has been the main driver behind the 7.1 percent annual growth rate in mining production. What is also noteworthy is the resurgence in several other mining series that were negative even six to nine months ago. Improvement in mining is all the more impressive considering the soft global economy. Growth across multiple series reflects healthy gains in consumer spending, machinery new orders, construction, energy and fabricated metals.

In the utilities sector, annual growth in Electric Power Generation, Transmission and Distribution Index is a mild 2.0 percent and slowing. Renewable energy recently passed a milestone. For the first time non-hydroelectric power (solar, wind, bio-fuels) surpassed hydroelectric power.

Nondefense capital goods new orders, a reflection of business-to-business spending, rose 4.6 percent in the 12 months leading up to June, to a record $964.2 billion. Going forward, spending will moderate into mid-2015 before reacceleration takes hold. The consistently strong growth rates in new orders over the past year were in industrial machinery (26.1 percent), metalworking machinery (11.6 percent), construction machinery (10.9 percent), HVAC (8.0 percent) and material handling (7.5 percent). Other segments have had uneven results this year. The May and June data saw improvement in some series, including consumer goods, computers and electronics, electrical equipment, motor vehicle bodies and parts, and primary metals.

Corporate America is still holding about $2 trillion in cash. We expect the rate of growth for new orders to decline between now and mid-2015. This will be followed by a stronger investment in capital goods as we move through the latter part of 2015 and 2016 as companies expand capacity and increase efficiencies.

Private nonresidential construction is rising on terra firma. The last three months to June rose 11.0 percent over the year earlier. Though spending remains well below the December 2008 peak, the general direction for nonresidential construction is improving. Private commercial building construction increased 11.2 percent from one year ago (annual basis). A healthier consumer is pushing year-over-year growth in multi-retail construction (24.6 percent). Warehouse construction (26.2 percent) is being bolstered by online retailing direct-to-consumer distribution.

Annual water and sewer construction sits just 0.6 percent below one year ago. State and local governments are beginning to see benefit from the economic recovery. Severe drought conditions are driving demand for innovative water conservation and recycling systems and technologies both here and abroad.

Annual spending for wholesale trade of durable and non-durable goods is growing at 5.3 and 6.1 percent, respectively. The pace of rise in wholesale trade will decelerate in early 2015, but will not become negative.

The post-recession recovery is in year five. And while there are many sectors that are growing at a healthy pace, the trends have been uneven. Growth is steadier and spread across multiple markets. The rate of growth will slow as we move into 2015—not overt decline, but softening. While we are optimistic about the prospects for growth over the next three to four years, we also would insert a measure of caution about establishing linear projections based on the past couple of years.

Competition from Southeast Asia remains a challenge. Businesses are still hesitant to pull the trigger on some large expenditures. Margins are tight. Global uncertainty has upended some opportunities and impacted currencies. Healthcare costs loom large, but remain an unknown. Skilled employees are hard to find. The stock market could correct at any time.

But it is time to turn away from the crash site. Avoid the noisemakers, especially those predicting cataclysmic change in the near term, or you risk losing the upside potential of the next four years. Now is the time for aggressive planning and preparation. Develop new products for new markets. Hire and train for growth. Move beyond any uncertainty about government action or inaction, and push yourself and your company where it needs to be.

Now is a good time to spend money to make your products better, your market position stronger and your future secure.

>> Alan Beaulieu, alan@itreconomics.com, is President of the Institute for Trend Research (ITR). The ITR blog can be found at http://www.itreconomics.com/blog.

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