The NAM/IndustryWeek Manufacturing Index -- Sales Predicted to Grow 3.5% Over Next 12 Months

While sales and investment prospects improved slightly, expectations for pricing power, employment and wage growth slowed while inventory investment expectations deteriorated.

By David Huether, Chief Economist, National Association of Manufacturers

After falling to a survey record low in the first quarter of 2009 and then improving for five consecutive quarters, the business outlook for manufacturers remained essentially unchanged in the third quarter of 2010. The share of respondents to the National Association of Manufacturers (NAM)/IndustryWeek Manufacturing Index with a positive business outlook edged up to 75% in the third quarter from 74% in the second quarter.

The level of optimism remained essentially unchanged after improving significantly over the prior year -- indicating that manufacturers do not expect conditions to improve over the coming year.

The NAM/IndustryWeek Manufacturing Index is a quarterly survey of NAM members that began in the fourth quarter of 1997.

When the economy entered recession in the fourth quarter of 2007, 70% of respondents to the NAM/IndustryWeek Manufacturing Index had a positive business outlook. By the first quarter of 2009, this level of optimism had fallen to just 28%. By the first quarter of 2010, the share of survey respondents with a positive business outlook had returned to 70%. After improving in the second quarter of 2010 to 74%, the share reporting a positive business outlook edged up to 75% in the third quarter -- the highest level of confidence since the second quarter of 2007.

The underlying detail shows mixed results for manufacturers in the third quarter. While sales and investment prospects improved slightly, expectations for pricing power, employment and wage growth slowed while inventory investment expectations deteriorated.

Results of the third-quarter survey are based on the responses of 260 members of the NAM. Companies recorded their business outlook as well as their 12-month expectations on sales, prices, capital investment, inventories, employment and wages.

The Business Outlook

After falling to a record-low 28% in the first quarter of 2009, the share of survey respondents with a positive business outlook rebounded for a sixth consecutive quarter to 75% in the third quarter of 2010 (see Chart 1) -- the highest level since the second quarter of 2007.

Five quarters into recovery, confidence in the third quarter of 2010 is higher than the 54% that had a positive business outlook in the first quarter of 2003, five quarters after the end of the 2001 recession (see dotted red line in Chart 1). This is consistent with the fact that the manufacturing recovery, to date, has been stronger than the initial upturn following the 2001 recession, which was held back by accounting scandals, the aftermath of the September 11, 2001 terrorist attacks, an overvalued dollar and sluggish growth abroad that together constrained export growth.

On a cautionary note, the pace of the improvement in manufacturers' business confidence slowed again in the third quarter -- after improving by 9% in the first quarter and by 4 percentage points in the second quarter, it edged up just 1 percentage point to 75% in the third quarter. This signals that the manufacturing recovery could be losing momentum, which is not surprising given the fact that the temporary growth supports such as inventory restocking and fiscal stimulus measures are now largely in the past.

As Table 1 below shows, the slight improvement in the business outlook from the second quarter was caused by a 2-percentage-point decline in those who were "Somewhat Negative" and a 1-percentage-point increase in respondents who were "Very Positive" and "Very Negative."

Sales Expectations

Respondents to the third quarter 2010 survey expect their sales to increase by 3.5% over the next 12 months. This is a slight improvement from the 3.3% growth anticipated in the second quarter. The acceleration in sales expectations in the third quarter is more modest than the increases earlier in the year and is consistent with a recovery that will not likely accelerate significantly in the near-term.

The expectation of 3.5% sales growth over the next year is measurably higher than the 2.1% growth that was expected in the first quarter of 2003, five quarters into recovery following the 2001 recession (see red dotted line in Chart 2). This is consistent with the fact that the manufacturing recovery following the 2001 recession did not gain appreciable momentum until the first half of 2004.

Pricing Expectations

Looking ahead 12 months, respondents to the third quarter 2010 survey expect their prices (the prices of their overall product line) to increase by 1.2%, a slight deceleration from the second quarter, when expectations were for a 1.4% increase.

While this is the sixth consecutive quarterly expectation of positive pricing power, the fact that inflation expectations moderated slightly in the third quarter is another signal that the recovery could moderate in the near-term.

Still, manufacturers have more pricing power than they did five quarters into the last recovery. In the first quarter of 2003, respondents to the NAM/IndustryWeek Manufacturing Index expected their prices over the next year to edge up just 0.6%. This is partly because the value of the dollar was still relatively high in early 2003. This put downward pressure on import prices, which held down domestic manufacturers' pricing power at the time (see Chart 3).

Investment Expectations

Looking ahead 12 months, manufacturers expect their capital investment expenditures to increase 1.9%, according to results of the third-quarter 2010 survey. While still modest, it is the third consecutive quarterly report of positive capital expenditure plans, which is somewhat heartening.

At a comparable stage in the last recovery, in the fourth quarter of 2002, manufacturers' investment expectations were a more subdued 0.6% (see Chart 4). This is consistent with the fact that business investment (outside of high-tech equipment) in GDP accounts declined during two of the subsequent four quarters. Therefore, only a modest upturn in manufacturers' outlays on capital investment should be expected over the coming year.

Inventory Expectations

Respondents expect inventory levels to edge down by 0.2% over the coming year (see Chart 5). This is very similar to the expectations of the past two quarterly surveys and signals that after improving significantly from the first quarter of 2009 to the first quarter of 2010, much of the inventory rebound has now taken place. As a result, this support for growth in the manufacturing sector will not be significant in the coming year, which is consistent with underlying fundamentals.

Manufacturers' inventories are not as lean as they were in the latter part of the past expansion in late 2007. In fact, the inventory/sales ratio for manufacturing overall has been edging up over the past quarter. Given the expectation that the economy and manufacturing will likely grow at a modest pace in the coming quarters, partly due the gradual winding-down of fiscal stimulus measures, inventory investment will likely moderate a bit to bring levels back in line with sales over the next year.

Employment Expectations

A year ago, in the third quarter of 2009, respondents to the NAM/IndustryWeek Manufacturing Index expected employment at their companies to edge up by 0.1% by the third quarter of 2010. This turned out to be nearly identical to the actual 0.3% increase (36,000 jobs) in manufacturing employment reported by the U.S. Department of Labor during this time.

Going forward, employment expectations of survey respondents are for payrolls to increase by 1.1% over the next 12 months, which is down slightly from the 1.3% employment growth expectation reported in the second-quarter survey.

Based on total manufacturing employment of 11,670,000 in the third quarter of 2010, a 1.1% increase would be equivalent to an increase of 128,370 over the next year. This would be a deceleration from the 136,000 increase in manufacturing jobs during the first three quarters of 2010 and is another sign that the expansion is not poised to accelerate.

Wage Expectations

After accelerating for four of the prior five quarters, wage growth expectations moderated slightly in the third quarter of 2010. Wages are expected to grow by 1.3% over the next year, slightly slower than the 1.4% growth expected in the second quarter (see Chart 7).

The current expectation of wage growth over the next year is 28% slower than the comparable time in the last recovery (first quarter 2003) and provides more evidence that the labor market will improve only gradually over the coming year. In addition, the modest growth expected in wages will likely act as a constraint on near-term consumer spending.