On Monday, we learned that U.S. factories are expanding at their fastest pace in more than two years, capping the manufacturing industry’s best six-month period since the recession ended in June 2009.
November’s closely-watched Purchasing Manager’s Index from the Institute for Supply Management rose to 57.3, its highest reading since April 2011. The data was solid across the board. Export orders were up, as were hiring intentions and new orders.
That kind of factory activity should translate into real economic growth of more than 3 percent in the fourth quarter, though most economists feel it probably won’t. In fact, the consensus view is that the U.S. economy is slowing down and will sputter through the final three months of 2013. The average forecast of economists surveyed by Bloomberg is for U.S. gross domestic product growth to come in at 1.8 percent in the fourth quarter. That’s well below the 2.8 percent growth from last quarter, which could very well get revised above 3 percent when the Bureau of Economic Analysis issues its second estimate on Dec. 5.
Why the pessimism? For one thing, there’s a bit of a disconnect between the ISM survey and the hard numbers collected recently by the U.S. Commerce Department, which indicate that factories are pulling back. For example, in September, orders for durable goods such as cars and appliances dropped 2 percent.
While it’s a good proxy, the ISM measures manufacturing sentiment, rather than actual activity. “That’s one of the things that’s troubling to me,” says Scott Brown, chief economist at Raymond James & Associates. “A lot of the data for shipments and orders is soft, so you have to take the ISM with a grain of salt.”
Another reason for pessimistic fourth-quarter-growth forecasts could be affirmed in the minds of many economists if third quarter data gets revised up. In other words, the stronger the third quarter, the weaker the fourth quarter. That’s because much of the boost to third quarter output appears to be a function of companies having restocked inventories. Given the relatively weak state of demand both at home and abroad, companies won’t need to order new items until next year. Thus, many worry that July and August are stealing growth from October and November.
“We had a very strong contribution to GDP from inventories during the third quarter,” says Paul Ashworth, chief U.S. economist at Capital Economics. As a result he says, “It’s not likely going to be a great fourth quarter.”
On the other hand, some believe the economy is gaining momentum as we close out the year. Joseph LaVorgna, chief U.S. economist at Deutsche Bank (DB), thinks GDP will grow 3.5 percent during the fourth quarter. That’s a whopping disconnect from his peers, but LaVorgna’s no slouch. His forecast for last month’s ISM number was closer than most; while he may tend toward the more optimistic side, he usually gets the trend correct.
LaVorgna’s buoyancy is based on the same data that are making other economists so blue about the current quarter’s prospects. Rather than thinking the recent shelf-stocking will be a drag on the economy over the last three months of the year, LaVorgna thinks it’ll give it a boost.
In a note to clients he sent out on Monday, LaVorgna argues that it’s largely a myth that big inventory builds one quarter eat into subsequent growth the next. “History suggests a large inventory build in one quarter tends to lead to a near similarly-sized build in the ensuing quarter,” writes LaVorgna. The correlation between the increase in inventories from one quarter to the next is about 75 percent. Which means business investment may not go all cold turkey after all. And rising inventories generally mean good news for workers: longer hours, more pay, and ultimately, more jobs.
Of course, the tepid sales from last week’s holiday shop-fest don’t exactly give the impression of a voracious consumer. Though American consumption isn’t quite the driver of growth it once was, it’s still what makes the engine go.
