While, the service sector does
account for well over 80% of overall economic activity, industrial production
often provides a very timely indicator implying the end of the business cycle
and the onset of a recession. The pro-cyclical nature of the report provides
a well-timed and sensitive indicator of the current rate of growth in overall
output. We expect that the September industrial production report based on
our forecast of a -1.4% print will confirm other grim data that the market
has observed in the manufacturing sector and looks to provide a strong signal
that the business cycle has reached its end and the American economy has
entered a recession.
As always, the devil is in the
details. On first glance, industrial activity picked up in the early summer
due to the increase in production caused by the settlement of the strike at
American Axel, a key supplier of parts to the domestic automotive industry.
However, during the second quarter of 2008 total industrial production on a
year over year basis, contracted at a rate of -3.2%. Moreover, with domestic
light auto and truck sales in an advanced state of collapse, this implies
that auto assembly going forward will see another round of retrenchment.
Looking at the September
employment report total hours and overtime hours worked in the manufacturing
declined for the third straight month with noticeable declines in the primary
metals and fabricated metals sectors. Hours worked in natural resources and
mining declined 1.0% on a monthly basis.
Perhaps more troubling is the
decline in the September ISM report that saw the overall manufacturing index
decline to 43.5 and production collapse to 40.8 even in light of a sharp fall
in the prices paid category and still relatively decent demand from the
external sector that saw growth during the month. The combined evolution of
the data does strongly suggest that the economy has moved into territory
consistent with overall contraction.
Thus, we do not anticipate
that on a national basis that the manufacturing sector will see any growth
during the final two quarters of the year. Our provisional forecast is that
industrial production will contract at a rate of -0.7% in Q3'08 and -1.0% in
Q4. The risk to that forecast is to the downside due to an expected decline
in demand from the external sector going forward and the likely impact caused
by a stronger dollar in the coming months.
