despite all the obvious improvements . . .

Several of you asked how I can still be raising questions about the sustainability of the economic recovery at this “stage” — despite all the obvious improvements.

In my opinion, the single biggest obstacle to a sustainable recovery is the lack of significant job creation. Let’s pretend the elephant in the room is not there for a moment, and address a question that was asked about industrial production: If its improving, isn’t that a sign of a recovering economy?

That’s a perfect example of the “Frankenstein Economy.” At this very late stage of the recovery, industrial production is still down year over year. You read that correctly, industrial production is DOWN.

How is that possible? All the news has been so good, and corporate earnings so strong?

It turns out that all the production improvement, according to Ned Davis Research, has come from just three sectors: Technology (+25%), Automotive (+22%) and Energy (+5.5%).

Automotive is easily dismissed: 0% financings and rebates. Hardly the stuff of robust recoveries. Indeed, GM made more money last year from mortgages than from selling cars. So if this recovery is for real, and interest rates tick up, that engine of growth is kaput.

Technology growth is partially an echo of the Y2K upgrade cycle — but that only explains some of the improvements. Some of the numbers rflect the very low comparisons in the few quarters post 9/11. There are also some real cost saving technologies out there, and they are capturing a lot of the new enterprise installations. Software has been doing much better than hardware; In my opinion, that’s because its easier to quantify cost/benefit analysis from software.

Lastly, Energy could be reflecting the increased demand due to stimulus. If the economy was dramatically improving across the boards, I suspect energy demand would be moving even higher still.

Bottom line: Core industrial production is still negative year over year. The remaining sectors — Consumer Goods, Business Equiptment, Business Supplies, and Materials — comprise 71% of industrial production. The Core Industrial Production (ex – auto, energy and tech) contracted at annual rate of -0.4% last quarter.

That’s why I am less sanguine than some of my brethren. We’ve had a terrific stimulus based run; For the recovery to be sustainable, I need to see manufacturing activity must broaden.

Source: Ned Davis Research

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  1. Leonard Kreicas commented on Oct 22

    One analyst pointed out that Intel gets 50% of it’s revenue from Asia and Japan, which could lead to a scenario of Intel making and selling chips in Asia and showing increasing profits. People assume that if Intel’s revenue was increasing it’s helping the domestic economy. That’s true, but it could be the Asian domestic economy. Many European countries do over 50% of their business in the United States and Toyota builds and sells cars here, but sends the profits home.

    I came across the Intel by chance, so I can’t speak for how representative this is for other companies. The internet has profoundly affected IT services. In Russia Windows is free, so the cost of business is that much more profitable if an American company decided to transfer backoffice help there. Starbucks is expanding overseas, did McDonalds decades ago. In all these cases domestic companies can show improving sales and profits, yet not help create jobs here except for ancillary services.

    The math is that organic growth is limited by population growth, which is countries such as Italy can’t get untracked. For a while economic growth can be fueled by improved standard of living such as in China or exporting products. However once a country maxes out its standard of living, superheated growth becomes very difficult.

    Once companies such as Boeing had a lock on the world’s airplane production and had healthy growth prospects. Ditto for military aircraft. Technology is still an area where America excels, as well as medical research.

    Investors need to be cognizant of the everchanging dynamics of markets and
    not rely on outmoded concepts.

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