In April, Industrial Production rose 0.8%, which was in line with consensus expectations. The revisions to previous months’ data was more or less a wash, with growth being revised up in March by 0.1% to 0.2%, and for January it was revised up by 0.2% to 1.2%.
That was offset by a 0.4% downward revision to February to -0.1%. While that downward revision makes it no longer possible to say that Industrial Production has been rising every month since last June, the overall revisions don’t really change the picture that much.
Behind the Headline Numbers
When one looks just a bit beyond the headline numbers, the data looks even better than the 0.8% growth implies. For starters keep in mind that these are month to month changes, not annual rates. On a year over year basis, total industrial production is up 5.2%. If the April pace were maintained for a full year, industrial production would be up 10.0%.
More significantly, total industrial production is not just the output of the nation’s factories, but of its mines and utility power plants as well. Utility output is affected by the weather as much as it is by economic activity.
Utility output fell for the third month in a row, falling 1.3% in April after a 6.1% plunge in March and a 1.7% decline in February. On a year-over-year basis, utility output is down 2.6%. That is probably not good news for electric utilities like Otter Tail Power (OTTR) and Pepco (POM).
Just looking at manufacturing gives a better sense of where the economy is going. Manufacturing expanded by 1.0% in April, matching a 1.0% rise in March (revised up from 0.9%). January also saw 0.9% growth, which was also revised up from 0.9%.
In between, though, February saw output decline by 0.1%, and that had previously been estimated at up 0.2%. Year over year, manufacturing output is up 6.0%. However, if the April pace were maintained for a full year, output growth would be 12.7%. If the year-to-date pace can be maintained for the rest of the year, then we are looking at growth of 9.0%. That sort of growth rate almost sounds Chinese, or at least Indian. However, it is mostly due to a bounce off of very low levels last year, not an indication of long-term sustainable growth at anything like that sort of pace.
Mining Really Shining
The third component of Industrial Production, Mining, has been on an absolute tear recently. It showed a 1.4% increase in output in April matching its March increase, which came on top of even stronger numbers in the prior two months. Year over year, output is up 8.5%. However, on an annualized basis, through the first four months of the year it is up 23.9%.
I doubt that sort of growth is going to be sustainable, but it is impressive. Mining companies tend to be highly operationally leveraged, so those sorts of increases are very good news for mining companies with significant operations here — for example, Freeport McMoRan (FCX) and Cliffs Natural Resources (CLF).
Final Products
Output of final products rose 0.5% in April, matching its 0.5% increase in March. In February, final product output was down by 0.8%, but that was after a 1.7% increase in January. On a year-over-year basis, final product output is up 4.9%.
There are two basic types of final products: those used by consumers, and those used by businesses. Recently it is output of business equipment that has really been driving the increases in output. In April, business equipment output rose 1.0%, following increases of 1.1%, 0.3% and 1.5% in March, February and January, respectively.
Business equipment output is up 6.0% from a year ago, but if the pace so far this year could be maintained it would equate to 12.3% growth. Output of consumer goods is also growing, but at a more moderate pace — up 0.2% in April following an increase of just 0.1% in March and a 1.3% decline in February, but January was strong at 1.7% growth. Year over year it is up 3.8%, but if the pace so far this year were maintained it would only be 2.1% growth. If that reflects a change in the economy towards more investment in new productive capacity, and less emphasis on consumer consumption, it is very good news in the long run.
While industrial production has had a nice rebound, it still has a very long way to go to make up for the damage that was done in the recession, as it shown in the graph below (from http://www.calculatedriskblog.com/).
Capacity Utilization
The second part of the same report showed that total capacity utilization rose to 73.7% from 73.1% in March (revised down from 73.2%) and 72.8% in February. A year ago, total capacity utilization was at 69.2%. While the growth in capacity utilization has been impressive, the overall levels of utilization are still extremely depressed.
Just as a general rule of thumb, if the economy is operating at a capacity utilization rate of 80%, it is in a healthy sweet spot. The long-term average is 80.6%. If it gets up above 85% then the economy is in danger of overheating, and accelerating inflation should be a major concern to the Federal Reserve and prompt it to raise interest rates. Levels of 75% are associated with recessions, and prior to this downturn, we had never recorded levels below 70%.
The bottom for this cycle was hit in June at 68.3%, and the previous low was 70.9% hit in December 1983 in the aftermath of the Reagan recession. Thus while the direction looks good, we still have a long way to go to get back to healthy levels. This means that the Fed has plenty of leeway to keep short-term interest rates down for a long time to come.
Part of the year-over-year increase in utilization is a bit overstated, since the total capacity of the country declined by 1.3% (permanent closure of facilities) over the last year. With less overall capacity, it is easier to run the remaining capacity at a higher rate.
Breakdown of Utilization Numbers
The total capacity utilization numbers, like the numbers for industrial production, include factories, mines and utilities. As with industrial production, the utility utilization numbers are as much a function of weather as economic activity, and it is instructive to look at manufacturing alone.
Factory utilization rose to 70.8% from 70.0% in March (unrevised), and up from 69.2% in each of February and January. A year ago it was at 65.8%, and it also bottomed out in June at 65.2%. Its previous low was in December 1983 at 67.9%. The long-term average rate of factory utilization is a bit lower than total utilization at 79.2%, but in any case there are still an awful lot of factories that are not operating up to potential.
On the other hand, a full five-point swing in utilization over the course of a year is very big move. Think of the capacity utilization rate as sort of the employment rate (or employment to population ratio) but for physical capital, rather than for labor. Most of the decline in total capacity was in the manufacturing sector, with a decline of 1.0% (think about that as being analogous to people retiring and shrinking the labor force).
While factory utilization has been rising sharply, utility utilization has been sliding. It fell to 77.4% in April from 78.5% in March, 83.7% in February and 85.6% in January. It is actually down from 80.9% a year ago. Power plants are normally utilized at a higher rate than are factories — the long-term average utilization is 86.6%. Unlike factories, we have actually been growing our Utility capacity at a pretty fast clip, rising by 1.9% over the last year.
As one might expect from the production data, mines are very busy, with utilization rising to 90.7% from 89.4% in March and 88.1% in February and 86.3% in January. A year ago, mines were operating at 82.1% of capacity, and the long-term average is 87.5%. There have been some permanent shutdowns in the mining industry, though, and over the last year total capacity is down 1.0%. Still, the level is impressive and indicates that the mining industry is booming.
Stages of Production
The report also details utilization by stage of production. Not surprisingly, with mine utilization high, so is utilization of production for crude goods at 89.0%, up from 87.7% in March and 79.5% a year ago, and comfortably above the long-term average of 86.5%. The high utilization was aided by a shrinkage of 1.6% of capacity, however.
Utilization of factories making intermediate and finished goods is far lower, but is also on the rise (to keep crude, intermediate and finished goods straight, think Wheat, Flour, Bread). Intermediate production utilization was just 70.2%, up from 69.4% last month and 67.0% a year ago, and far below the long-term average of 81.6%.
For Finished goods, utilization rose to 71.8% from 71.6% last month and 67.6% a year ago and remains far below the long-term average of 77.5%. Intermediate goods have seen a 1.3% reduction in capacity over the last year, while finished goods have only seen a 0.7% capacity decline.
The Importance of Capacity Utilization
The capacity utilization numbers are some of the most under-reported of all economic statistics, and really should get far more attention than they do. The rebound we have seen since last summer is very encouraging, but we should not lose sight of just how deep a hole we had dug for ourselves by last summer. The second graph below (also from http://www.calculatedriskblog.com/) shows this.
Total utilization, while well above the low points of last summer and the worst point in the Reagan recession, it is still below the worst point in any other recession since the data started being kept in 1967. Yes, we are on our way back, but we still have a long journey ahead of us. This is not the time for the Fed to take its foot off the accelerator. The low absolute rates of capacity utilization will be an effective check on any acceleration of inflation for the medium term.
The recent strength of the dollar is also a force that will keep inflation low. This gives the Fed plenty of leeway to keep rates down.
The rebound in utilization is a big part of the reason that corporate profits are doing so well. So far with over 90% of first quarter reports in, total S&P 500 net income is running 45.4% above year-ago levels. The areas with rising levels of utilization, the manufacturing and material sectors, are leading the charge. On the other hand, profits in the utilities are up only 1.0%, by far the smallest increase of any sector.
The continuing rebound in utilization levels for factories and mines in April points to very strong growth again in the second quarter, while it seems likely that growth in utility earnings will remain tepid, and may very well actually decline in the second quarter.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.
