Durable Goods Orders Up in May - Analyst Blog

New Orders for Durable Goods rose 1.9% in May. That was above consensus expectations of an increase of 1.5%. In addition, the April numbers were revised upwards. It was first reported as a decrease of 3.6%, but now they say new orders fell “just” 2.7%.

Durable goods orders are a volatile series, and it is not uncommon for a big gain in one month to be followed by a decline the next. Still, these numbers are good news.

Part of the story was the extremely volatile Transportation Equipment side, and more specifically, from the Non-Defense Aircraft component, which is often the case when we get an unusually good (or bad) headline durable goods number. That is mostly orders for big 777’s and 747’s from Boeing (BA), which are very expensive items.

It also includes orders for business jets from firms like Textron (TXT). A few orders for new jumbo jets can really skew the numbers for the month. It was part of the story, but not all of it, as even without them the numbers were solid.

Excluding transportation equipment, new orders rose 0.6%, slightly below expectations for a 0.7% increase. Last month was revised upwards from fall of 1.6% to a drop of only 0.4%. Overall transportation equipment orders were up 5.8% in May, and non-defense Aircraft orders were up 36.5%. In April overall transportation orders were down 9.4% (revised from 9.5%), and non-defense aircraft were off 29.0% (revised from 30.0%).

Ex-Defense Orders

If one want to gauge how much demand for long lasting goods is coming from the private sector, then one needs to strip out orders from the Pentagon. Rising defense orders were also part of the rebound this month. Excluding defense, orders for durable goods were up 1.9% after falling 2.9% (revised from 3.6%) in April.

Last month’s numbers were revised higher, and that is the sixth month in a row that has happened. The durable goods numbers often have big revisions, and the odds are still that the revisions next month will be to the upside, by how much is very much of an open question.

Core Capital Goods

One of the most significant details of this report is what is known as “core capital goods.” Those are orders for non-defense capital goods, excluding aircraft. That is a very good proxy for what businesses are investing in equipment and software. That investment is a direct input into the GDP growth calculations, and one of the real bright spots for the economy in this recovery.

That is the sort of spending that is a bet on the economic future of the country, and is also one of the areas that trends to swing with overall economic conditions. Those swings are a big factor in determining if the economy is growing or shrinking.

On that front, the news so far this year had been one of steady improvement. May reversed a very disappointing April. Core capital goods orders rose by 5.6%. That is after a 5.4% drop in April, which was revised down from an original 2.6%% drop. Business investment in equipment and software has been one of the bright spots in the recovery. Its contribution to growth looks like it will be smaller in the second quarter, especially with the big downward revision to April’s numbers. The turnaround in May is encouraging.

The non-defense aircraft segment was the strongest part of this report, but that is not particularly unusual. Those numbers are volatile in the extreme. This month they jumped 36.5%. In April they plunged 29.0% (revised from a 30.0% decline). In February they posted an increase of 39.9% (revised up from 35.1%). Even that was tame relative to an eye popping 5,558.2% increase in January. That is not a typo, but a reflection of a total collapse of such orders in December. Did I mention that non-defense aircraft orders can be very volatile?

The rise in orders is good news not only for the big names like Boeing, and the big name suppliers like United Technologies (UTX) and Honeywell (HON), but eventually it is good news for thousands of much smaller sub-contractors as well. From the reports coming out of the Paris Air Show, it looks like June should be a good month for the non-defense aircraft segment.

Defense Aerospace Also Took Off

The defense side of Aerospace also rose, but not as sharply. Orders for defense aircraft rose by 5.5% after they dipped by 0.4% in April. There was a big upward revision to the April numbers as they were originally reported as a drop of 8.9%.

If the country is going to make any progress on bringing down the deficit, defense spending is going to have to be on the table, and that probably means very little growth in spending on new planes and helicopters. On the other hand, we do seem to be finding more and more places to use those Defense aircraft. Overall defense capital goods orders (including aircraft, but also tanks and ships and such) were up 3.9% reversing a 3.7% decline in April (revised from a 5.8% decline).

Orders for computers (and related gear) rose by 1.3%. Last month they were down by 1.3%. That was not nearly as bad as the 4.4% that was first reported. Orders for communication equipment were up 3.6% on the month. That, however, is after two months of declines. The April drop, however, was revised to 2.3% from a 3.4% decline. Orders for Machinery also rose, climbing 1.2%. April was revised upward to a gain of 0.2% from a decline of 3.4%.

Solid Report Overall

Overall this was a solid report. We came in better than expected but mostly due to the volatile non-defense aircraft area. More significant was the size of the upward revision to last month. The rebound was very broad based. Yes the usual suspects for a good number — aircraft and defense orders — were strong, but even if they are excluded, the numbers were OK and a nice change from April.

Even with the revisions, April was just plain ugly. Keep in mind is that this is a very volatile number, and big increases in one month can to be followed by decreases the next. There is, of course, no guarantee that that will happen in June.

There has been a distinct upward trend in the revisions, and the revisions in durable goods orders tend to be larger than for most economic indicators. Those sorts of revision trends tend to persist, so it is quite possible that we will learn next month that this months increase was even better than it looks now.

Anticipate Revisions?

The consistent upward direction of the revisions is reassuring, but should one try to adjust this months numbers on the expectation that the upward revision trend will continue? That seems like getting into dangerous territory to me.

Economic data collection falls into the non-defense discretionary spending part of the Federal Budget, and that is the area that has been most targeted for budget cuts. Sort of seems to me like trying to increase the fuel economy of a car by cutting off the power to the dashboard. You might save a few watts (or dollars) but it does not seem like a very good idea.

Given the month-to-month volatility in the numbers, it can be useful to step back and look at the longer term numbers. If we look at new orders in the first five months of the year, relative to the first five months of 2010, things still look pretty good. Overall, new orders are up 9.7%, and not a lot of difference if you strip out either transportation equipment (9.5%) or defense (9.6%).

The key core capital goods area is also doing very nicely on a year to date basis, up 13.0%. Defense capital goods orders, on the other hand, are down 10.1% on a year-to-date basis. Machinery orders have been a big part of the increase in core capital goods, rising 17.7% on a year-to-date basis.

The drop in April was disturbing, but it is very good to see some of that nastiness revised away and things seemingly getting back on track this month. The longer term picture is still solid. Perhaps the April slowdown was simply the combined effects of the Japanese disaster and some weather issues.

The first graph below shows the level of both total new durable goods orders and those of core capital goods. Clearly core capital goods have come back much further than total orders. From their peak in December 2007, total orders plunged 39.3% to bottom in April of 2009. Since then they have recovered by 31.5%, but still remain 20.2% below their pre-recession peak.

Core capital goods orders fell 30.6% from peak to bottom (April 2008 to April of 2009) but have since almost completely recovered and are just 3.4% below the pre-recession high.