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Wells Fargo Economic Commentary: Clear Picture of a Weakening Manufacturing Sector Continues to Emerge

07/05/2012
Source: Wells Fargo Securities Economics Group

Manufacturing Activity Pulls Back on Global Concerns
Marking the first reading below the key "50" level since July 2009, the ISM manufacturing index fell to 49.7 in June. On a related note, the June Markit U.S. PMI also pulled back, confirming the slower pace of manufacturing activity.

The biggest surprise was in the forward-looking new orders index, which plunged to 47.8 from 60.1 in May. New export orders also fell into contraction territory last month. Slower Growth Expected in the Second Half of 2012

Given the softening performance we have seen in other economic indicators, it is of little surprise to us that manufacturing activity continues to cool. Today's report will certainly cause the market to question the sustainability of the economic recovery in our opinion. With the European recession deepening and Chinese growth slowing, the pace of manufacturing activity should remain under pressure in the second half of the year.

Factory Orders Reaffirmed Manufacturing Sector Downshift
Factory orders bounced back in May, posting a 0.7 percent increase after two months of consecutive declines. New factory orders excluding the volatile transportation component rose 0.4 percent. Capital goods orders rose 2.3 percent for the month; however the rebound was not enough to compensate for the sharp pullback over the previous two months. The three-month annualized rate of capital goods orders declined 6.9 percent as of May suggesting that business investment will likely be much weaker in the second half of the year. Defense orders came back, posting a 7.7 percent increase after a sharp pullback in April.

In general, the report provided a modest upside surprise from consensus; however, the rebound was not enough to offset the pullback in new orders in March and April. When this data is taken into perspective with the regional manufacturing indices and the ISM survey, there emerges a clear picture of a weakening manufacturing sector. Weakening global economic conditions along with softer consumer demand and evidence of slower business investment lead us to believe that manufacturing production will continue to slow in the months ahead. We reiterate our view for subpar economic growth around 1.5 percent for the second quarter.

Upward Revisions to Initial Estimates
While factory orders remained fairly weak for the month, there was some good news in the report as orders for both durable goods and capital goods excluding nondefense aircraft were revised upward. Durable goods orders were revised higher to 1.3 percent from the originally reported 1.1 percent increase. Nondefense capital goods orders excluding aircraft also rose m0re than expected in May, increasing 2.1 percent as opposed to the originally reported 1.6 percent rise. Given the upward revisions to these numbers, the negative hit to the manufacturing sector has been reduced somewhat.

Shipments Rise as Inventories Remain in Check
Total shipments rose 0.5 percent for the month with shipments of durable goods rising 0.8 percent and nondurable shipments rising for the first time in two months, up 0.2 percent. Shipments of transportation equipment accounted for most of the rise in shipments, posting a 1.6 percent increase. The inventories-to-shipments ratio fell for to 1.27 months from April's 1.28 months, marking the first decline in the ratio since December 2011. The slight drop in the I/S ratio likely reflects the pullback in oil prices rather than manufacturers electing to hold less inventory on hand. Nondurable inventories, which capture oil inventories, have pulled back in each of the past three months coincides with the fall in petroleum prices. Inventories of nondefense capital goods excluding aircraft are still up, increasing 0.5 percent for the month.

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