The U.S. economy continues to be the bright spot among global economies. However, the leading indicator input we track is trending lower, signaling that a milder pace of growth will arrive as we move through the second half of the year. No recession in sight.
From a global perspective, slower growth persists in Western Europe’s industrial production, extending the current trajectory of stagnant economic conditions. This will characterize 2015. Conditions are projected to improve in 2016 and 2017, but the contraction this year will be severe enough that Western Europe will end 2017 only 1.4 percent above the current level of annual production. The decline in Western Europe has also become a drag on Eastern Europe’s annual industrial production, which has slowed for the sixth consecutive month.
Attempting to slow deflationary fears, the European Central Bank (ECB) has taken a page from the Federal Reserve Bank (FRB) playbook and plans to inject €1.1 trillion into the economy for (at least) the next 15 months. The impact of these new measures will vary from country to country within Europe, and are likely to have spillover effects into other regions.
Contrary to most headlines, the global, social and political issues reported about Iran, Iraq, Syria, Nigeria, Ukraine and elsewhere have had little significant impact on the U.S. economy through January. The S&P 500, which tends to overreact to global developments, is headed toward a record-setting six-year bull market this April. The strong U.S. dollar is one exception, benefiting foreign imports and hindering U.S. exports. Given quantitative easing taking place in Europe (and Japan), the U.S. dollar is expected to remain strong for the foreseeable future.
Manufacturing
The U.S. Industrial Production Annual Average Index, our benchmark for the U.S. economy, roared into 2015 up 4.2 percent. An additional rise is indicated by the internal rates of change. Annual production in high-tech industries also hit a record high, rising 6.1 percent above the previous year. We expect growth to run on the high side of our forecast range into mid-2015. A mild deceleration in the rate of growth is likely by year-end, as the impact of softening oil and gas extraction and slowing exports takes hold.
Upside momentum is clearly evident in two of the three segments in industrial production. Annual production in manufacturing, the largest sector (nearly 74 percent) of industrial production, rose 4.1 percent. Mining rose 9.1 percent over 2014, with no indication of slowing down. Interestingly, the oil and gas extraction sector of mining was still expanding in January, up 11.8 percent over the year earlier (annual basis). The laggard of the three segments is electric and gas utility production, which began the year down 0.5 percent (annual data). Production will see mild improvement as we move through the second half of the year.
Working consumers
One of the more significant implications of GDP results at the end of 2014 was that consumers are (finally) seeing the benefits of a stronger U.S. economy. Personal consumption expenditures rose 3.9 percent from the previous year. Fueling this growth was a 2.3 percent rise in annual average private-sector employment. The Bureau of Labor Statistics reported fourth quarter growth in output of 3.2 percent and an increase in hours worked of 5.1 percent, the most in 16 years. Compensation in private industry rose 2.1 percent, with a 2.1 percent gain in wages and a 2.6 percent increase in benefits.
All this is making for a happier worker and consumer. Real disposable personal income for Americans rose to 4.2 percent in January over the previous year. The January University of Michigan Consumer Expectation Index hit a 10-year high, and both the quarterly and annual revenues for retail sales (deflated) continued its record-setting pace. Lower fuel costs are helping, but the larger picture is the general health and strength of the U.S. economy. Growth in private sector business activity is benefiting the consumer. 2015 will likely see a shift from industrial strength carrying the overall business cycle to consumer strength doing the heavy lifting instead.
The ITR Leading Indicator declined for the fourth straight month in February as a more definitive, downward trend comes into focus. The indicator is now at its lowest level since late 2011, and is signaling slower growth in the U.S. economy in the second half of 2015. The U.S. Leading Indicator, which leans toward consumer/employment/credit trends/construction, while still in positive territory, is below the peak set in July 2014. We expect 2015 to expand, but at a slightly milder pace than 2014. There is no reason to hit the pause button. The above trends point to growth across broad sectors of the U.S. economy.
Fixed investment
Residential and nonresidential construction trends are broadly positive. Construction spending remains well below the dollars of the 2007 excesses, but more sectors have settled into the growth phases of the business cycle. Many of these sectors (warehouse, chemical, commercial, manufacturing, office and multi-family) are growing on an annual basis of double digits, some even as high as 20-50 percent above the year earlier (annual basis).
It is important to note that the current acceleration is not a repeat of 2006-2007. There is no evidence of speculative building or over-leveraging. The private sector is leading the way. State and local government construction is back in Phase B, the growth phase of the business cycle, with upside momentum in primary and secondary education construction. Federal construction spending remains recessionary, with little evidence of improvement in 2015. Annual private residential construction rose 15.2 percent. We expect ongoing growth for this sector over the next three years.
Business investment
A less than cheery trend may be developing in business investment, as measured by non-defense capital goods new orders (excluding aircraft). There was no year-end bounce. A weak November was followed by a mild December, followed by some improvement in January. However, the internal signals are suggesting that growth is slowing. The softening in new orders is evident in another of our leading indicators, the ISM’s Purchasing Managers Index. The raw data slipped from the August 2014 apex of 58.1 to 52.9 in February, the weakest reading in a year. Though 52.9 is still above the contraction benchmark of 50, the decline is clearly a signal to us that growth in this economy will slow. We do not foresee this triggering a full-blown recession. The pullback in capital expenditures in likely a reflection of the strong dollar.
On the bright side, computer and electronics new orders are up 3.9 percent, with total revenues of $266 billion. Annual metalworking machinery new orders rose to a record-high $38.6 billion in 2014, 5.2 percent above the 2013 total. Wholesale trade of durable goods continues to be strong, rising 5.8 percent (annual basis). All 11 sectors of wholesale trade that we track rose over the past 12 months.
A major driver for machinery demand has come from the transportation industry. North America light vehicle production is approaching 14-year highs, and will grow further over the next three years. Heavy-duty truck production is also rising at a double-digit pace, and railroad and rolling stock production, shipbuilding and repair production, and civilian aircraft equipment production are all expanding as well. With ongoing rise likely in all of these industry segments, producers will need additional equipment and upgrades as they look to expand capacity.
Where to put your focus
What should business leaders focus on in 2015-2016? Don’t look at the next four years as a repeat of the last five. Stop looking in the rearview mirror. Develop aggressive strategies for growth. Invest in process, equipment and people to meet increasing demand through 2018.
Stated unemployment numbers continue to decline. Despite more than 5.0 million job openings, there is a shortage of qualified workers. Everywhere we give presentations, business leaders tell us they can’t find workers. A main focus should be developing a detailed plan for hiring and training new employees. Also make sure you retain the (key) employees you have.
Finally, be sure to lock in cost ahead of rising wages and inflationary pressures heading into 2016.
>> Alan Beaulieu, [email protected], is president of the Institute for Trend Research (ITR). The ITR blog can be found at www.itreconomics.com/blog.
