Industrial Production is flat in May

Industrial ProductionEnlarge GraphIndustrial production is a bellwether of economic activity

Industrial production is a good top-down macroeconomic indicator, which helps forecast the labor market, final demand, consumption, and inflation. While manufacturing is no longer the primary driver of the U.S. economy, it still influences the economy to a large degree, particularly for unskilled workers. U.S. manufacturing is undergoing a bit of a renaissance lately due to cheap energy prices. While there is still a difference between wages overseas and here, low natural gas prices are offsetting that. Also, as wages rise overseas, the cheap labor arbitrage is fading away. The Fukushima nuclear disaster also demonstrated how elongated supply chains are vulnerable.

Increases in industrial production generally signal increases in employment. Lower skilled workers have struggled since the financial crisis which has dampened aggregate demand and consumption. Things are finally starting to improve as construction jobs rebound and more companies are starting to on-shore production.

April numbers fall off after weather artificially increases the prior month

Industrial production rose by 0.04% in May after falling .43% in April. On a year-over-year basis, production rose 1.6% from a year earlier. Utilities and machinery fell, while auto parts and mining rose. Utilities fell as an unseasonably cold winter / spring has turned into an unseasonably cool start to summer. Overall, the report suggests that the global slowdown is flowing through to industrial production, but that the US still remains in an expansion.

Implications for home builders

Home builders are highly sensitive to the economy. Any sort of slowdown can leave them with excess inventory, and if home prices do not rise, they are stuck with depreciating inventory that costs them to maintain and finance. They will look at the production numbers and conclude the economy is still expanding moderately. If anything, increasing production portends an increase in hiring, which is definitely bullish for the economy.

Recovery in the home building market is going to be driven primarily by first time home buyers. They are still struggling to find jobs, and until we see employment growth back to normalcy, it may be difficult to see the 1.5 million housing starts that are typical of an expansion. We recently broke 1 million, which historically has been a very depressed level.

Home builders have experienced quite the renaissance over the past year as the home builder ETF (XHB) has rallied. Rising real estate prices seem to be driving increases in orders. As the economy improves, renters will begin to become more comfortable with the idea of home ownership. Given the cost of renting is way higher than the cost of owning, marginal increases in the overall state of the economy and confidence will drive home demand. Specific home builder stocks that will be positively affected by changes in consumer sentiment include KB Home (KBH), Lennar (LEN), NVR Homes (NVR), Standard Pacific (SPF) and Toll Brothers (TOL).