#671 – U.S. Manufacturing Primed for Another Growth Year, Part 2

As we noted last week, economists see positive signs for manufacturing as we move into 2018. Below is the second part of the article we featured in last week’s Agurban.

US Manufacturing Primed for Another Growth Year, Part 2

There are several positive, somewhat related signs for the manufacturing outlook in the domestic economy.

First, U.S. inventory investment is simply too low. Although the contribution of inventories to growth can be volatile from quarter to quarter, inventories tend to grow in line with final sales over longer periods of time. Today, that simply is not happening; inventories have been trailing the growth in domestic demand. If the economy expands at 2.2%, the rough trend since the end of the recession, inventories would need to grow by about $50 billion per year to keep pace with demand. Inventories ran below that level in 2017. That means factories are likely to go into overdrive to boost inventories in coming quarters.

The auto industry is a prime example. After hurricanes Harvey and Maria, a replacement rebound in auto sales took a bite out of inventories. With sales continuing to come in somewhat stronger than expected, there is a good chance carmakers will ramp up their production schedules for this year.

Second, the recovery in business investment should help lift the factory sector. After all, about one-tenth of total industrial production is business equipment. Typically, when labor markets are tight, companies seek alternative ways to meet demand. Business fixed investment tends to be stronger when the unemployment rate is below the non-accelerating inflation rate of unemployment, or NAIRU, as it is widely expected to be today. Loose financial conditions will also help. Stronger stock prices have a tendency of helping ease lending standards on commercial and industrial loans, which, in turn, lead investment spending.

Third, the housing market is on the mend. Construction supplies and appliances represent about 5 percent of total industrial production. Nevertheless, both areas, like the housing market more broadly, remain well below prior cyclical peaks. Housing demand continues to outrun supply and builder sentiment is elevated. Expect construction activity to strengthen in the coming year, providing a tailwind for manufacturing.

In short, don’t expect manufacturers to slow down any time soon; there’s plenty of reason for solid growth ahead.

By Neil Dutta, who is the head of economics at Renaissance Macro Research, and is responsible for analyzing global trends and cross-market investment themes.

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