-Manufacturing Slowdown "Much Deeper Than Anyone Imagined"
--Lack of Capital Investment Raises Future Inflationary Risks

By Mark Pender
NEW YORK (MktNews) - The U.S. manufacturing sector disappointed expectations that an upturn was at hand as the National Association of Purchasing Management's July report (PMI) showed renewed weakness centered in employment and inventories, according to Survey Chair Norbert Ore.
The purchasing managers' index came in at 43.6, showing a sharper contraction in manufacturing activity compared to the once promising 44.7 in June. Ore expects the PMI to return to its pattern of the first five months of the year, lateral movement in the low to mid 40s.
Ore said July's index is equal to 0.3 percent growth in gross domestic product, plus or minus one percent. "We could easily already be in economic contraction," Ore said. Ore made his comments in interviews following the mid-morning release of the report.
"Obviously, the manufacturing sector has stalled - this particular downswing is different from '91 and '81, in terms of the slowness of the recovery and the depth of the problem. It's much deeper than any one imaged."
Ore believes the third-quarter will be very similar to the second quarter, that is, another disappointing period of slow growth at best. He said the economy is likely "to border on recession in the next couple of months," though he held out hope that GDP may rise to a 1.5 percent trend by early next year.
Ore expressed disappointment that the PMI has not been able to rally from its lows early in the year. He said the sector is still looking for a "driver," namely stimulus from prior Federal Reserve rate cuts and the Republican tax rebate.
Ore said capital investment measures hit a low for the survey. He warned that the continuing decline in capital equipment investment may spell inflationary troubles once the recovery does kick in. He said stagnant production capabilities raise the risk that manufacturers may not be able to meet future demand, in turn leading to higher prices for goods.
Central in the sector's problems is the strong dollar, which continues to restrict exports. Ore emphasized that the economic recovery will have to arise from the domestic consumer, as foreign consumers and businesses, themselves suffering, will be unable to afford high priced U.S. goods and services.
This puts new importance on the report's employment reading, which edged up slightly in July to 38.7 but continues to show sharp contraction in the manufacturing work base. Referring to the Milwaukee purchasers' report, which breaks down blue and white collar workers, Ore said managers are now becoming victims of job cuts. He emphasized that employment cuts are a result of poor corporate earnings, which are forcing company officials to protect margins by cutting back payroll. Inventories contracted sharply in the month, well beyond Ore's expectations. The report's two inventory readings, producers' raw materials and customers' finished goods, both made new lows in the cycle. Ore said the reductions reflect the sharp weakness in the sector but may also offer a silver lining, as lower inventories may usher in a new period of higher production.
"You have to look for inventories to move up. You can only liquidate so much before you get it right," Ore said. Ore repeated his warnings early in the year that new technologies would not reduce the degree of dislocation in inventories, that better inventory management "does nothing" to help gauge cyclical turning points nor their degree.
Prices paid fell sharply, down to 38.7 from 42.3 in June. Ore said the decline reflects lower energy prices, which is a positive, but also weakening level of demand for products. He warned that lower prices will weigh on corporate margins, in turn hurting employment and ultimately the consumer.
His outlook for prices, though, is positive. "I think we'll see prices relatively flat between now and the end of the year, that we won't see a lot of pricing power in any industries," he said, holding out hope that prices will begin to firm early next year.