Numbers That Matter: Adjusted for inflation, plastics are underperforming

There is growing evidence from the first half of 2023 that indicates the plastics industry is feeling the full weight of the Fed's efforts to quell consumer demand by raising interest rates.

You will recall its tightening policy started over a year ago, and history suggests it was going to take about four or five quarters for the full impact of this policy to take effect. This means we have just arrived at the sweet spot of the expected timing for this policy to produce results. And as the chart shows, the recent data from the plastics industry is in decline.

According to the latest report from the Federal Reserve Board, the June index value for the U.S. production of plastics products was 100.6 (2017=100). This represents a decline of 5 percent from the June value of a year ago. The data started to drop at the end of last year, and for the year to date, the volume of plastics products manufactured in the U.S. is also down 5 percent when compared with the first six months of 2022.

By comparison, the index measuring the total industrial output so far this year is flat. Plastics is clearly getting hit harder than most other industries.

In order to understand this decline better, we have to look at other data sources. I should restate at this point the data compiled and reported every month by the Fed measures the volume of industrial output in the U.S. Many of the other macroeconomic data sets that are useful for our purposes are reported in dollar terms. But if the past year has taught us anything, it is that periods of high inflation can distort the underlying trends in this data.

Over the long term, the trend in the overall plastics industry data will tend to correlate with the trend in the overall U.S. economy. And the data we have so far suggests the U.S. economy actually expanded during the first six months of this year. It grew slowly to be sure, but it expanded. This slow growth corresponds nicely with the flat trend in the overall industrial production data during this time, but it does not explain a decline of 5 percent in the output of plastics products during this stretch.

We also know that over the long term, the trends in the volume data from the Fed will tend to converge with the trends in other data series reported in dollars if the rate of inflation is stable. This data reported in terms of dollars measure value, not volume. Sometimes this data is adjusted for inflation, but not always. In these cases, I have to make the adjustment for inflation myself. But if I do this, then I can often garner additional insight into the trends in market demand for plastics products.

Here are a couple of examples of how I analyze the trends in this data.

Every month the Census Bureau reports on total U.S. retail sales. This widely followed report, which includes a breakdown of the major types of retail establishments, is a valuable source of market information for some of the major end markets for plastics products. However, this data is reported in dollars. I can dig into the Census Bureau's website and retrieve data that is either seasonally adjusted or not seasonally adjusted. But it is not adjusted for inflation.

If I want clues about end market demand for certain types of food packaging — a large, important category for the plastics industry for which there is not much well-documented data — then I can analyze the retail sales data for grocery stores.

Through the first six months of 2023, total sales at grocery stores (in dollar terms) are up 3.9 percent when compared with the same period a year earlier. This growth rate is higher than the long-term average for this data. During typical years, I would take this as an indication that the demand for plastics packaging was favorable.

But this year, the overall rate of inflation in the U.S. economy during the first half of 2023 was 5 percent. If you adjust the data for grocery store sales by the rate of overall inflation, then you get an adjusted value for grocery sales of roughly negative 1 percent. This suggests the actual volume of grocery sales has either declined or shifted to other types of products that are less expensive. Either way, such a shift in demand can negatively affect the output of products such as plastic caps, closures or containers.

Another example I analyze regularly is the relationship between housing starts and retail sales of building materials and garden supplies. Both of these data sets are important indicators of demand for many types of plastics products.

This year, total housing starts are down a precipitous 15 percent when compared with the first half of last year. The housing starts statistics are reported in units, so no adjustment for inflation is needed here. A decline of that magnitude in the starts data is likely a significant reason the trend in the data from the plastics industry is down by 5 percent this year.

Obviously, the decline in new houses started will negatively affect the demand for plastic building materials such as pipe, siding and windows. It also affects the demand for many types of common household goods made of plastic. A good indicator of demand for these goods is the trend in the retail sales data for establishments that sell building materials and garden equipment and supplies. I think of these as the typical big-box stores, and here again the data is reported in dollars, so it needs some tweaking to allow for the impact of the short-term price hikes we experienced over the past year.

Through June, sales at this category of stores are down 2 percent from last year. After we apply our rough adjustment due to inflation, demand at this major end market for plastics products might be down by as much as 7 percent in 2023. This is another strong indicator of weakening demand and declining production volume for many types of plastics products.

I will have to save other examples of this kind of analysis for later columns, but there is one more point from the chart I want to mention. I graphed 20 years of data because I want to show the peak it hit in 2006. Output dropped dramatically during the Great Recession of 2009, and it has never fully recovered.

The output from the first six months of this year is about the same as it was in 2017, the base year used for this index. From this I surmise that onetime challenges such as pandemics and inflation are not the only issues this industry must address.