A manufacturing survey and employment reports from last week have people worried about the state of the economy because of its drop since May. Many people are left wondering whether the economy is heading back toward a recession or if we are just experiencing another minor setback. While acknowledging that the economy is poor, I believe it will regain some momentum in the second half of the year.
The Japanese earthquake is no longer front-page news, however, its consequences are increasingly affecting the manufacturing world. Each month, purchasing managers complete a survey of business conditions. There are two surveys, one for manufacturing and one for services. In recent months, the manufacturing survey has been quite strong with readings over 60% (anything over 50% indicates an expanding economy). For May, this reading dropped to 53.5% from 60.4% in April, leading to a 2% drop in the market that day.
This weakness was clearly centered in the auto industry. Through April, auto sales were running more than 13 million units annualized, but declined in May to only 11.8 million. Inventories were being depleted due to parts shortages, dealers lowering their discounts and a weakening in consumer demand. In May, the average price of a new car reached a record level of $29,800.
Until recently, expectations were that Japanese car plants would not get back to full production until about November. However, on June 1, Toyota reported that it expected production for June to be at 90% of pre-earthquake levels in Japan and at 70% in North America. With other manufacturers on similar timetables, it appears that normal production levels should be achieved by July. This should allow for car sales and pricing to return to normal for the second half of the year.
Clearly, the only 54,000 new jobs created in May was a disappointment as opposed to the 232,000 figure in April. However, unlike the manufacturing survey, which registered a significant drop in May, the services report actually rose to 54.6% for May from 52.8% in April. Since the service sector is larger than manufacturing, this implies the overall economy is still expanding.
Looking forward, I expect business conditions to remain sluggish for a few more months, but when auto production returns to normal, there will be some lift in the economy. Still, until there is some recovery in housing, the economic recovery will remain modest compared to historical standards.
The recent weakness in the market is not surprising given recent economic news and the 20% rise in stock prices from last September through April. At current levels, stocks seem fairly valued, though for those whose stock allocations are low, the recent correction does provide an opportunity to increase holdings.
