When studying economic cycles, sequence is one of the most important relationships to understand. The order or sequence of economic data is far more telling than any individual data point that can be taken out of content, subject to large standard error and of little value as a standalone measure.
From a high level, a standard sequence involves a reduction in demand for a good, followed by rising inventories. As inventories swell and demand fails to follow through, new orders for more inventory decline which pressures the manufacturer. When new orders decline, producers will reduce the hours worked of production level staffing as the slowdown may prove temporary.
If the decline in demand is not transitory and reducing the hours worked of production level staff proves insufficient, layoffs are the next logical step. Income growth declines and this has a circular flow back to consumption.
To give an example, if we look at any individual employment report, that data is highly noisy and little information can be gleaned from any of the thousands of internal metrics reported in the employment situation report.
Sequence, however, can provide information as it pertains to which sectors are slowing, where declines in employment may be expected and more.
If consumption slows, production drops, hours worked declines, and then we see a decline in employment, that is significantly more informative than a random drop in employment that may fall within the standard error of the report.
The sector that we should all be watching now as it pertains to the global and domestic economic deceleration is the auto sector. Much of the declines in global and domestic manufacturing and the ancillary effects that come with a manufacturing slowdown are a result of a sharp decline in Chinese auto sales and a slowdown in US auto sales. Unsurprisingly, China is now attempting new auto stimulus measures.
With that said, let’s have a brief look at the US sequence.
Reported in the BEA Personal Income & Outlays report, we have personal consumption expenditures which makes up about 70% of US GDP.
Within personal consumption expenditures, we can look at the breakdown of services and goods (durable goods and non-durable goods).
Durable goods is the most cyclical measure of consumption containing items such as motor vehicles and parts, household appliances, jewelry, watches, boats, airplanes, and other large ticket items.
US durable goods consumption growth has fallen below 1% to one of the slowest growth rates of this economic cycle.
If we dig into the durable goods section, a large portion of the decline is stemming from motor vehicle & parts consumption as well as the consumption of major household appliances.
The consumption of motor vehicles and parts is declining at a rate of 4.23% year over year as reported by the BEA.
Has production started to slow? Well, if we look at the recent Federal Reserve report on industrial production, we can see that the growth rate of production in the automobile segment has a -30% delta. Auto production from the IP report has fallen from +23.5% year over year to -10.43% year over year in a matter of months.
Following the sequence, we should expect this to have a negative impact on the hours worked in the manufacturing sector.
Sure enough, if we aggregate hours worked and average overtime hours worked for production workers in the manufacturing sector, we see that weekly hours are declining at a growth rate of 1.53% year over year. This data can be found in the BLS employment situation report.
Instead of boring you with the layer by layer analysis, we can skip right to the auto sector which is dragging aggregate manufacturing lower.
The growth rate of the average weekly hours in the motor vehicle and parts sector is contracting at a rate of 2.23% year over year.
As the sequence suggests, should a decline in manufacturing payrolls be surprising given the current trend, even if the decline falls within the standard error?
We have seen consumption decline, production decline, weekly hours decline, the next shoe to drop is employment which makes the latest decline in manufacturing payrolls curious, to say the least.
It is highly possible that the recent payrolls data will be revised and any single report does not equal a trend.
Inside the employment report, we see, however, that the decline in manufacturing payrolls also came from motor vehicles and parts.
The point of this analysis was to show that there are pockets of the global and domestic economy that are slowing significantly. If we want to watch for a rebound, we now know where to look.
Lastly, the longer this slowdown persists, the greater the probably this slowdown has to leak into the services sector as wage growth in the manufacturing sector is already contracting.
Digging into the Personal Income & Outlays report shows that wages & salaries for manufacturing, adjusted for inflation, are contracting at 1.4% year over year.
A slowdown does not mean a recession and it does not mean a stock market crash. Ignoring the slowdown and saying that manufacturing does not matter is a dangerous game if the deterioration happens to leak into broader services.
The slowdown in the auto sector should be an area that everyone is paying attention to as it pertains to the economic cycle.