You’re ridin’ high in April, shot down in May. — Frank Sinatra
I am pretty certain that Frank was not singing about economic data or manufacturing statistics, or even about the plight of plastics market forecasters, in the opening lines of his iconic version of That’s Life. But these lyrics aptly describe what happened to the data on U.S. industrial production and GDP in recent weeks. Just when it appeared we had escaped the icy grip of a harsh winter and were poised to take the next step forward in this economic recovery, we get a couple of data reports that suggest the recovery might have taken a step backward.
A few days ago, the monthly Industrial Production Index from the Federal Reserve Board reported that the total output from U.S. factories declined in April when compared with the previous month. More specifically, the Fed’s index for output of plastics products slipped from 95.5 in March to 94.8 in April. This release from the Fed followed a report from a couple of weeks earlier in which the Bureau of Economic Analysis reported that the U.S. economy grew by a scant 0.1 percent in the first quarter. And this figure may yet be revised downward to show that overall economic activity might actually have contracted in the first three months of 2014.
Now if you have read any of my previous columns, then you know that my forecasts for this year call for accelerating growth in both overall economic activity as well as output from U.S. manufacturers. This includes a solid annual gain of 5 percent for plastics processors. So what am I to make of these recent data? And do I need to change my forecast and lower my expectations for this year? Before we do anything, let’s take a closer look at the data so we can better understand what happened.
We will hear more news reports on the first quarter GDP data in the coming weeks because it will be revised two more times, once at the end of this month and then again at the end of June. And as I said, the quarterly growth rate may well be revised downward into negative territory. If overall economic activity continues to decelerate beyond the first quarter, or even contract, it will have a significant effect on our forecast for the plastics industry.
The good news is that the data on personal consumption expenditures (PCE) in the first quarter, a measure of consumer spending, grew by a solid 3 percent. The PCE total accounts for about two-thirds of the total GDP data, and sluggish growth in consumer spending has been a major reason for the sub-par rate of growth in the overall economy since the recession ended. A growth rate of 3 percent in PCE over the long-term is just about ideal.
But this past winter the increase in consumer spending was mitigated by sharp declines in residential investment (primarily in new houses), exports, business inventories, and business investment in new equipment. It should be noted that investment in industrial machinery, the category that includes plastics machinery, actually increased in the first quarter.
I learned long ago not to put too much emphasis on the data from just one month or even one quarter, especially if the data in question deviates from the longer-term trends. And that is what happened here. None of the above-mentioned declines are consistent with the longer-term trends in these data. The data on residential investment has now declined for two consecutive quarters, but prior to that, the trend was strongly upward. And this is certainly an area where weather could have been a significant factor. Two straight quarters of declines raises a red flag, but it is not yet enough determine that the long-term uptrend has reversed.
All manufacturers, including plastics processors, need to monitor the housing data closely because this is the most important factor in a stronger economic recovery this year and beyond. The trajectory in the residential construction sector did flatten out in the second half of 2013 and the first quarter of 2014. But right now all of the ingredients needed for a more robust recovery are in place, so I am fully expecting this data to gather momentum in the coming months.
As for the data on both exports and business investment, the respective declines in the first quarter followed solid increases in both of these sectors in the fourth quarter of 2013. It is not clear whether the weather was a large part of the problem in either of these categories, but I will wait another quarter or two before I determine that the overall trend in either of these data has turned down. And while negative numbers are usually bad, the large drop in private inventories in the first quarter may actually turn into a good thing going forward because many of these inventories will ultimately be replenished. This will generate positive numbers in the inventories data in the current quarter and beyond.
So for the time being, I will attribute the sluggish or even negative growth in the headline GDP data for the first quarter to one-time factors that will be corrected in the coming months. The early indications are that the second quarter data is growing at a rate of 3 to 4 percent. If this holds true, then the economic recovery will be back on track and our current forecast of 3 percent growth for all of 2014 will not need to be adjusted downward.
A closer look at the prevailing trend in the industrial production data shows that the small decline in the April data was most likely the result of the outsized gains in the data from February and March. This happens frequently in economic data, and economists and statisticians have a name for it: regression to the mean. The idea behind either a regression to the mean is that large deviations from the prevailing trend, either positive or negative, are almost always followed by a data point that is closer to the long-term average.
And if you look at a chart of the industrial production data over the past couple of years, you will see a clear trend of steady growth despite the fact that the data has been unusually volatile during the past few of months. So the data that measures the output of plastics products in April did register a small decline when compared with March, but it fell no lower than right back to the longer-term trend line. Put in numerical terms, U.S. production of plastics products has expanded by an annual average of a solid 5 percent per year during the two year period from 2012 to 2013. For the year to date in 2014, the rate of growth is 4.5 percent. Our forecast for 2014 as a whole remains unchanged at a gain of 5 percent.
Trends do change, and one day I may well have to forecast a downtrend in the economic or plastics industry data. But I do not think that today is that day. So for now I’ll stick with Frank and his bold prediction that we’ll be “back on top, back on top in June.”
Bill Wood is economics editor for Plastics News, and is the founder and president of Mountaintop Economics & Research Inc.