Is manufacturing climbing out of its hole?
Chicago purchasing managers showed that manufacturing activity might be improving. The PMAC survey jumped in June to 44.4 from a level of 38.7 in May. This brought the business barometer to its highest level since last December. Not all components of the index increased, but production, new orders and order backlogs were higher than a month ago. Keep in mind that any level below 50 percent still reflects a contracting sector. The jump in the index from May to June only signals that the rate of decline may be slowing. As evident in the chart, this index tends to move in the same direction, albeit not by the same magnitude, as the NAPM survey which tracks manufacturing activity in the nation as a whole. This could be pointing to a pickup in the NAPM survey for June. (It will be reported on Monday.) .

The Chicago purchasing managers' survey was not the only sign of life in manufacturing. New orders for manufacturers' durable goods increased 2.9 percent in May, reversing about half of the previous month's drop. The ever-reliable indicator of volatility, aircraft orders, did rise in May, but overall orders picked up as well. Among the major components, primary metals, fabricated metals, machinery, electrical equipment and transportation all gained for the month. Computers and electronics also increased, but among its subcomponents, communications equipment and computer orders were down. Orders for semiconductors surged 35.3 percent in May but only reversed the April drop, though perhaps it may signal some bottoming out. .

On a year-over-year basis, total durables and nondefense capital goods orders are both down sharply. It will take more than one month's gain to turn around this sector. The May rise in new orders won't guarantee a near-term pickup in industrial production. However, if new orders continue to climb in the next couple of months, then production may start gaining by the end of the summer. It is possible that the Fed was counting on such improvement when they decided to reduce the federal funds rate target by 25 basis points this past week instead of by 50 basis points as they had the previous five months. .

Home sales are range bound
Sales of existing homes rose 2.9 percent in May to a 5.37 million-unit rate, reversing about two-thirds of the previous month's drop. At the same time, new home sales inched up 0.8 percent in May to a 928,000-unit rate after declining 4.5 percent in April. In both cases, home sales are above year ago levels. Home sales apparently peaked in the summer of 1999 and headed lower through 2000 when interest rates peaked. Total home sales reached a new peak for this cycle in March, and the May level is nearly on par. Given the drop in mortgage rates over the past year, it isn't entirely surprising that home sales would remain healthy. However, the run-up in home sales in the late 1990s was attributed to the "wealth effect". The drop in the stock market from its 2000 peak would indicate that the wealth effect should go into reverse. But home sales have held tight. .

Ironically, the housing market has not really benefited by the aggressive easing undertaken by the Federal Reserve this year. Home sales have remained strong in the past few months despite the fact that mortgage rates have ticked higher. Mortgage rates dropped in tandem with Treasury yields in advance of the Fed rate cuts. By the third rate cut, mortgage rates were actually headed higher (as were Treasury yields on 10-year notes). .

A few economists (it is definitely the minority) have claimed that the U.S. is in recession. Even the National Bureau of Economic Research, which is the official arbiter of business cycle turning points, indicated in the past week that the economy may be skirting a recession. One would certainly expect home sales - and consumer spending - to be declining if that were the case. Home sales appear to be reaching new highs and we haven't seen a quarterly drop in consumption expenditures either. This may be another factor that caused the Fed to decrease the funds rate by only 25 basis points instead of 50 this past week. .

Fed officials cited consumer confidence as a deciding factor in its first rate reduction in January. Recent improvement in consumer sentiment may also have played a role in the Fed's smaller rate cut. Both the Conference Board and University of Michigan measures increased in June. Levels are still well below a year ago, but they are an improvement from the beginning of the year. While many economists (at least outside the Fed) tend to take confidence surveys less seriously than actual economic data such as retail sales and housing starts, this is another indicator that doesn't jive with the recession commentary. Typically, confidence would fall during a recession and not improve until well into the recovery phase. .

Old news
The Commerce Department's final revision showed that real GDP grew at a 1.2 percent rate in the first quarter, just a touch higher than the 1 percent rate of growth posted in the fourth quarter of 2000. All major components recorded gains in the first quarter. Most noteworthy was a narrowing of the net export balance, which helped to boost GDP in the first quarter rather than act as a drag (as it typically does). Real final sales surged at a 4.3 percent rate in the first quarter after growing at a modest 1.7 percent rate in the previous quarter. Real final sales expanded at a faster rate than GDP because business inventories were liquidated in the first quarter. Remember that the drop in industrial production was caused by a necessity to align inventories with sales. Now that final sales have grown more rapidly than GDP for three straight quarters, it is more likely that the inventory correction is nearly complete and that economic growth can resume later this year. .

The revision in GDP also extended to corporate profits. Not surprisingly, profits were revised down for the first quarter to show that after-tax profits declined 7.4 percent from a year ago. This confirms other profit measures that market players have already seen. Note that changes in the Dow Jones Industrials appear to lead changes in profits by a quarter or so. The chart below shows that the Dow Jones Industrials are up just above the zero line in the second quarter. This could mean some profit improvement at the end of this year. Most analysts are predicting that profits will pick up by the beginning of 2002. .