Analyzing August's key industrial economic data

Part 2

Empire State Manufacturing Index dips, but still good for builders

The Empire State Manufacturing Survey is a barometer of economic conditions in New York State

The survey is put out by the New York Fed and covers a wide range of economic indicators—from general business conditions to new orders, shipments, unfilled orders, delivery times, inventories, prices paid and received, headcount, and average workweek. It also asks businesses for their outlook six months out. It’s a relatively comprehensive survey of business conditions, but it concentrates on New York State, which is a small subset of the population. Like most Fed surveys, it employs a diffusion index methodology, asking respondents whether a certain metric is getting better, getting worse, or staying the same. The index value is the percent of respondents who say the metric is getting better less the percent who say it’s getting worse.

Empire State Manufacturing SurveyEnlarge Graph

Index increases and approaches “normalcy,” while internals improve markedly from last month

The general business conditions index slipped 2 points, and closed at +6.2 (26.6% of respondents reported better conditions, while 20.4% reported worse conditions—so the net result is 6.2%), which was a slight drop from last month. The headline general business conditions survey was the highlight of the report. The New Orders index rose 2 points to 2.4, and the shipments index jumped 15 points to 16.4. While this report isn’t a blowout by any stretch, it does show that the weakness from late spring and early summer was transitory. The employment outlook fell, but the six-month outlook brightened.

Every month, the Empire State Manufacturing Survey goes in depth on some business theme or statistic. The theme has been anything from the Affordable Care Act to a midyear report. This month, the question concerned selling prices. One of the themes we’ve been seeing has been increases in input costs—specifically commodity costs, energy, and labor—with no increases in selling prices. This is a recipe for compressing margins, which is bad for stocks and job growth. The survey showed that raising selling prices continues to be difficult due to competitive dynamics, although pricing power may be getting better. Of respondents, 60% said they planned on hiking prices by 2%, compared to 50% at this time last year. The Fed would love to see an increase in prices, as 3% inflation with 3% wage growth feels a lot better than 1% inflation and 1% wage growth.

Implications for homebuilders

Overall, the report shows the economy is still expanding moderately, and firms are generally optimistic about the future. Consumer sentiment is driven first and foremost by jobs, and nothing in this report indicates that employment conditions will get materially worse. One worrying sign is that plans for future employment fell slightly, but they were still non-negative. Employers expect the average workweek to increase, and plans for increased capital expenditures increased slightly. Overall, you could consider the report a modest positive for homebuilders.

The increase in consumer sentiment is starting to drive more business for homebuilders like Ryland (RYL), Meritage (MTH), KB Home (KBH), Toll Brothers (TOL), and NVR (NVR). Housing starts have been so low for so long that there’s some real pent-up demand that will unleash as the economy improves.

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