(Schwab Analyst)
Capital spending partially to the rescue
On the surface, the July durable goods orders report released on Aug. 24 didn’t look supportive of the economic expansion. The overall index fell 2.4%, down from June’s 3.5% increase. Much of the decline was attributable to the volatile aircraft industry. Motor vehicle and defense orders also fell.
Yet, the report contained noticeably upbeat capital spending news. I’m referring to the proxy for capital spending known as nondefense capital spending excluding aircraft. Typically, trends in new orders for this series are used to gauge the strength of capital spending. I prefer to take it three steps further by including the monthly change for shipments, unfilled orders and inventories.
Nondefense capital goods excluding aircraft
May June July Year-to-date
Shipments 0.0% 0.1% 1.3% 9.2%
Unfilled orders 1.1% 1.6% 1.6% 14.3%
Inventories 0.0% 0.6% 0.7% 4.6%
New orders 1.3% 1.4% 1.5% 10.3%
As you can see, each category shows a strong upward trend.
Don’t let the rise in inventories alarm you. Inventories typically rise for one of two reasons—either demand unexpectedly fell, or inventories were intentionally built in anticipation of increased future demand. The weight of the evidence strongly suggests the latter.
And this means?
On August 30, the revision to second quarter gross domestic product (GDP) is scheduled for release. The original estimate of 2.5% is forecast to be revised up to 3%. Beyond that, many are wondering if GDP could contract sometime down the road. While the chances have increased for such an outcome, I believe the likelihood is low.
An excerpt from Federal Reserve Board Chairman Ben Bernanke’s speech that he gave at the Federal Reserve Bank of Kansas City's Thirtieth Annual Economic Symposium in Jackson Hole, Wyo. today helps explain why: “Perhaps most important, technological advances continue to play an important role in facilitating global integration. For example, dramatic improvements in supply-chain management, made possible by advances in communication and computer technologies, have significantly reduced the costs of coordinating production among globally distributed suppliers.”
Bernanke is referring to ease of movement and reduced costs. That’s great news to any central banker because it implies greater productivity and tame inflation.
Yet I see another positive economic development associated with supply-chain management: inventory overhangs are less likely. That is, today’s corporations have the ability to produce at a high level yet with relatively low inventories. This concept is sometimes called just-in-time-inventories; and on a related concept, just-in-time-deliveries.
Past recessions were caused, in part, by slow response times by corporations to unexpected declines in demand. They were stuck with too much product on their shelves. Yet I believe the leanness and responsiveness of today’s corporations will likely go a long way toward minimizing the depth and duration of an economic slowdown.
I see GDP growth decelerating down to 2% to 2.5% for the balance of the year. While it’s possible to see a further slowdown in the first half of 2007, I still expect some degree of economic expansion. I base this cautious optimism on my expectation of favorable capital spending, lean inventories, the potential for lower bond yields and the willingness of the Fed to cut short-term interest rates if conditions warrant. |
