Manufacturing outlook moves lower

Production weakened considerably during Q2 and is unlikely to rebound any time soon. After growing at a 5% clip for the prior 3 quarters, industrial production grow at just a 2.2% rate in Q2. With the obvious weaknesses in both our domestic economy and the global markets, we don’t anticipate getting growth much higher than 3% over the next year or so. The reduction in export activity is definitely hurting manufacturing and is unlikely to rebound significantly in the near-term. We still believe that industrial production should remain modestly above GDP growth, but that difference has been slowly erasing as our forecast has once more been reduced.

Outlook
Manufacturing remains an important source of freight-movements. The industrial sector led the recovery during 2010 and 2011 (5.4% and 4.1%, respectively) and is expected to show reasonably strong growth for 2012 before we start showing weaker growth after that. Still, it remains above the GDP forecast, although we expect that premium to slowly dissipate over the next year or so. Industrial production is forecast to increase 4.1% in 2012, 2.6% in 2013 (down from 3.4% last month), and 3.0% in 2014.

Despite the recent pullback in the forecast, we expect the manufacturing portion of the economy to remain a stronger force in the economic recovery than it has been during recent history. This is good news for the truck sector since a single manufactured product has a huge multiplier effect on freight movements.

Analysis
June production actually showed reasonable growth from May but April and May were revised lower and that led to a weaker than anticipated Q2. The annualized growth rate in Q2 was just 2.2% – last month we were at 3.3% and just 2 months ago we were above 5%. A reduction in numerous export sectors combined with a pause in the automotive sector to dramatically slow growth.

Despite the recent downgrades we continue to remain optimistic about continued growth in the industrial sector over the next year or two. During this upturn it has been significantly above GDP growth for most of the time. That difference is narrowing but is still there. Other forecasters remain more pessimistic than us about manufacturing growth next year, but we have been moving towards that reality. The ISM data moved into negative territory in June, the first time since xxx. That is a very worrisome outcome. If the ISM remains in negative territory for more than a month or two then we are likely overstating the industrial sectors output for the rest of this year. Still: Autos are doing good, exports have slowed but haven’t gone away, Chinese demand isn’t going away any time soon, and the U.S. consumer is still doing something (just not enough). The biggest concern continues to be if exports falter further. There are also big risks for our economy, but they are above the entire economy and will impact all sectors of the economy if they do happen.

Changes
A few key sectors saw notable changes in the forecast this month. Once again, Chemicals activity was reduced as our chemical markets continue to remain subpar – despite a large advantage coming from our low natural gas prices. Exports are partly to blame, but chemicals production has been nearly flat since the start of 2010. Whether this activity ever returns to normal remains a worry.

Metals production also continues to slow. This is mainly a slowdown in the growth rate of automotive production combined with slowing of export markets for industrial machinery and raw metals. The Lumber & Wood sector has been reduced as housing is slowly turning around but other construction and export markets slow. Weak infrastructure/business construction and agricultural issues have lowered our outlook for extraction of Bulk Aggregates.  One item that improved this month was Coal Mining as it has finally hit bottom and is slowly recovering from an extremely weak winter.

Risks
The risks to the economy have moved significantly higher over the last few months and are worth keeping a close eye on for the next 3-6 months. Europe, Oil, China, and our own political standoff are all potential catalysts for a worse economic environment.