In June, total industrial production inched up by 0.1% from May and was up 8.2% from a year earlier. However, that is the output not just of the nation’s factories, but of its mines and utilities as well. Hotter-than-normal weather drove a big increase in utility output that distorted the figures. The output of the nation’s factories fell by 0.4% for the month, but is still 8.3% above year-ago levels.
The total industrial production index has been up every month but one since last year. The 0.1% increase this month is a major slowdown from the 1.3% gain posted in May and is also below the 0.3% increase in April, and is the worst showing since the unchanged reading in February, which was at least partially due to the blizzards of that month. The performance was slightly better than the unchanged reading that was expected.
The manufacturing output is also the first decline since a 0.3% decline in February, and is the worst showing since May of 2009. Utility output rose by 2.7% in June on top of a 5.6% rise in May, but that was after a 4.4% decline in April. Year over year it is up 7.1%. Given how much weather can affect the utility portion of the overall report, looking at the manufacturing only figures gives a much better sense of where the economy is headed.
Mine output is a relatively small part of the overall picture, though it rose 0.4% in June after dropping 0.3% in May (but rising 1.7% in April). Mine output includes oil and gas production, and the drop in May was probably due to lower output of oil in the Gulf of Mexico due to the BP (BP) disaster. Relative to a year ago, mine output is up 8.5%.
Overall production of finished products fell by 0.2% for the month, but is up 8.2% year over year. In May, production of finished products jumped by 1.6% after a 0.1% decline in April. Year over year, production is up 8.2%.
Production of business equipment has been much stronger than production of consumer goods on a year-over-year basis, with business equipment output rising 11.3% vs. just a 6.8% increase in consumer goods output. In June, business equipment production rose 0.9% while consumer goods output fell by 0.6%.
Capacity Utilization
Total Capacity Utilization was unchanged in June at 74.1%, but that is up from 73.1% in April and just 68.2% a year ago. It was slightly below the 74.2% level that was expected. The year-ago level was an all-time record low.
As a general rule of thumb, 80% capacity utilization represents a nice healthy economy (the long-term average level is 80.6%). If it rises to 85%, it is showing signs of overheating and the Fed needs to take steps to rein things in or inflation will tend to heat up. A level of 75% is normally associated with a very deep recession.
The year-ago level was simply off the charts on the downside. The increase of 5.9 points of capacity utilization over the last year is highly significant, but we still have a very long way to go.
Having more than a quarter of the nation’s total industrial capacity sitting idle is probably a much bigger factor in inhibiting businesses from investing than is any uncertainty about tax or regulatory policy coming out of Washington. After all, if you have a factory with, say, 12 lathes, and three of them are sitting idle and gathering dust, what are you going to tell the lathe salesman if he asks you if you want to buy another?
To some extent the improvement is a bit overstated, since the total capacity has declined by 0.5% due to permanent plant and mine closures. If capacity shrinks, it is easier to run the remaining capacity at a higher percentage.
As with the industrial production numbers, the total capacity utilization numbers include utilities, and as such can be influenced by the weather. Factory utilization actually fell to 71.4% from 71.7% in May, but is still above the 70.9% level in April. The May and April numbers were both revised down by 0.2%.
A year ago, factories were operating at just 65.4% of capacity. The long-term average for factory utilization is 79.2%. Thus as with the total utilization, we have made significant progress over the last year, but still have a very long way to go. It is not clear if this is just a pause or the start of a new downturn in production. The inventory replenishment bounce seems to be over, though.
Mine utilization rose to 86.1% from 85.8% in May and is slightly above the 86.0% level of April. Unlike factories, mine capacity has actually increased by 0.3% over the last year. The big increase for the month was in utility utilization, as power plants produced more electricity in response to hotter weather and air conditioning demand. Utility utilization jumped to 82.3% from 80.2% in May and 76.1% in April. A year ago, utilities were operating at 78.6% of capacity. The long-term average is 86.7%. Utility capacity is up 2.3% from a year ago.
Stages of Processing
By stage of processing, plants producing crude goods saw utilization rise to 85.0% from 84.6% in May but down from 85.1% in April. Mines make up a much larger percentage of the crude good output than of finished goods. A year ago, crude good utilization was 78.3% and the long-term average is 86.5%. Utilization at plants that make semi-finished goods (steel would be a good example) rose to 72.1% from 71.6% in May and 69.9% in April. A year ago semi finished utilization was at 65.7% and the long term average is 81.6%.
Finished good utilization fell to 72.6% from 73.2% in May, but was slightly above the 72.5% level of April and well above the 67.5% level of a year ago. As with the other measures, we still have a long way to go to get back to the long-term average, which is 77.6%.
In Summation
Overall, this was a disappointing report. While on both the industrial production and capacity utilization sides the total numbers were roughly in line with expectations, we managed to hit the numbers only because of the utility side of things. Hot weather is a potential sign of global warming (and even there it could just be noise), not a sign that the economy is getting better.
It might be a good sign, though, for the upcoming earnings reports for some of the big electric utilities like Con-Ed (ED) and Southern Companies (SO). Yes, we have made significant progress relative to a year ago, but the year-ago numbers were just plain awful. The level of capacity utilization, particularly for manufacturing, is still extremely depressed. As the graph below shows, the current levels are roughly in line with the worst points hit in most recessions.
The idle capacity we have is a sign that aggregate demand is still way too low. This is not the time to be going on an austerity binge and cutting back on stimulus, both monetary and fiscal. With lots of factories mothballed, it does not make a lot of sense for businesses to invest in upgrading existing ones or building new ones. That is a much bigger factor in holding back business investment than any uncertainty about new regulations coming out of Washington.
Companies have by and large done an extremely good job at cutting costs, and the level of profitability given the low level of capacity utilization is extremely impressive. However, unless they feel confident that the customers will be there, they are going to be content to sit on cash and not invest for the future. For any given firm, that makes sense. However, the collective decision not to invest means that the economy is slower, and thus each firm has fewer customers.
The caution that businesses are showing about investing is rational, and not particularly evil on the part of any given business. Collectively, though, it is harmful to the economy. The very low levels of capacity utilization are one more reason why inflation is not going to be a major issue anytime in the near future. That means that the Fed will be able to hold down interest rates for a very long time.
Indeed, a good case can be made that the real danger is deflation, and that the Fed should be taking additional steps to increase the money supply, perhaps by buying more mortgaged-backed paper. Low interest rates will help the banks like JPMorgan (JPM) and Wells Fargo (WFC) make a lot of money through the steep yield curve, and thus repair their balance sheets.
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.
