Recent sluggishness in industrial sector will fade

The Federal Reserve Board recently released its industrial production report for the month of May, and the overall numbers were disappointing. Total output for U.S. factories declined 0.2 percent for the month. This marked the fourth time in the past six months that domestic manufacturing output has posted negative growth.

This is not all that surprising because many manufacturers have been hurt by the sharp rise in the strength of the U.S. dollar. Because of the sluggish performance so far this year, I have modestly lowered my forecast for 2015 to a gain of 2.6 percent for total U.S. industrial production.

But I still expect steady improvement during the second half of this year.

The negative effects of a stronger dollar and the corresponding dip in oil prices will gradually dissipate in the future, and both of these developments will ultimately turn into positive factors in the overall U.S. economy. But it will take a few more months for all of the producers and consumers in the global marketplace to adjust. So right at this moment, the short-term negative effects are mitigating the long-term benefits.

On a more positive note, the total output for U.S. plastics products increased by 0.2 percent in May. The plastics industry is not quite as vulnerable to fluctuations in the currency markets as are some other industrial sectors, and the drop in crude oil prices is actually beneficial to the domestic plastics industry. The capacity utilization rate for the plastics industry also ticked up 0.2 percent, and now stands at 79.3 percent.

The prevailing trends in these data are important to plastics processors for a couple of reasons. First, all sectors of the U.S. plastics industry are affected ultimately by total industrial production. The plastics data and the overall data may occasionally diverge for short periods of time, but over the long run the trends are closely correlated.

On the accompanying chart I have plotted the rates of growth for both U.S. production of plastics products and total U.S. industrial production. Make note, this is not a graph of the actual output volumes. It is a chart of how fast the output data are growing. On this chart, anytime the plastics line is above the total line, it means that the production of plastics products grew faster than the total during the previous 12 months.

This chart illustrates a couple of interesting trends. First, it is clear that the long-term growth in total industrial production in the U.S. averaged somewhere in the range of 2 to 3 percent per year during the past 10 years. It dipped down much lower than this during the last recession, and the subsequent rebound was muted, but on average the growth rate has been pretty consistent.

This stability is a good thing. It inspires confidence because it requires strength. It encourages investment in productive assets with long life spans. I know that everybody is always hoping to be above average, and we all believe that faster is better. But the U.S. has a large, diverse, and well-developed economy. Strong, steady and sustainable is right in the sweet spot of where we want to stay.

Plastics data vs. other industries

Another trend that merits attention is that the plastics industry grew by below-average rates for most of the decade from 2001 through 2010 — but during the past three years that situation was reversed. Since 2012, the volume of output from the U.S. plastics industry has expanded at a robust pace that was significantly stronger than most other industrial sectors.

In terms of total volume, the U.S. plastics industry has not quite recovered all of the production it lost in the recession. But at the current pace of growth, the industry will hit a new historical peak later this year. My current forecast calls for annual growth of 5 percent in total output in 2015. This is a solid rate by historical standards. But given the performance of the past three years, my forecast may be a bit conservative. Obviously, I will watch it closely and keep you apprised.

The second reason I monitor these data closely is that the industrial sector represents a major end market for many types of plastics products. It is true that the majority of plastics products are sold into consumer end markets (automotive, medical, packaging, etc.), but a substantial number of our readers supply the industrial sector.

As part of our quarterly Plastics News Business Monitor survey, we calculate an index that measure activity levels for the industrial end market. The most recent reading for the Industrial Index is 103.6 — a reading above 100 indicates that activity levels for suppliers to the industrial markets increased during the quarter. In the first quarter, strong gains in new orders, production levels and payrolls were partially mitigated by decreases in export orders and backlogs.

The Business Monitor Index value for the entire plastics industry in the first quarter was 104.5, so a value of 103.6 for the industrial end-market indicates that business conditions in this sector were not quite as vigorous as they were for some other end-markets. This makes sense because as noted above, the growth in the industrial sector has been slightly negative over the past six months. But the underlying fundamentals in the U.S. economy are steadily improving, and after a short lag, I remain confident that the overall industrial sector data will reflect this improvement.

Our survey also indicates that processors who supply the industrial markets are just as optimistic about the future as the overall industry, and their plans for capital spending are moderately higher. When asked about their main concerns about the future, they are significantly more worried on average about the uncertainty in the global economy and the increasingly competitive global marketplace.