Recent data show relative strength in demand and output in the manufacturing sector, with activity levels reflecting improvements since earlier in the year. In particular, the latest Institute for Supply Management’s purchasing managers’ index has reflected robust growth in new orders and production since the summer, and employment and pricing pressures appear to be moving in the right direction. The forecast for real GDP and industrial production for 2015 also show promise, both of which are anticipated to expand by roughly 3% next year.

That is not to suggest a smooth road ahead, as there are challenges. The slowing global economy, a still-cautious consumer, rising interest rates, a stronger dollar, and tax and regulatory uncertainty could each pose downside risks to U.S. economic growth. Along those lines, manufacturing production and retail sales numbers have been softer than desired in the autumn months, and export sales growth has continued to be sluggish in light of economic challenges abroad.

Manufacturing Leaders Have a Positive Outlook

With that said, manufacturers in the most recent National Association of Manufacturers (NAM)/IndustryWeek Survey of Manufacturers remained mostly optimistic, at least for now. Indeed, 91.2% of respondents were either somewhat or very positive in their own company’s outlook (Figure 1). This continues an upward trend that began in the first quarter of 2013, and it was only the fourth time since the survey began in 1997 that the outlook measure has been 91% or better. The last time was in the fourth quarter of 2005. Parsing this data out by firm size, larger manufacturers (i.e., those with 500 or more employees) were the most positive, with slightly more than one-quarter saying they were very positive; in contrast, only 18.8% of the smallest manufacturing firms (i.e., those with fewer than 50 employees) were very positive.

Stronger sales expectations supported the better outlook in the fourth quarter. Manufacturers predict sales to grow 4.5% on average over the next four months, up from 4.1% in June and 4.4% in September (Figure 2). This marks the fastest pace since the first quarter of 2012. In the most recent survey, 77.3% of respondents forecast increased sales over the next year, with nearly 49% predicting sale growth of 5% or more. Medium-sized manufacturers (i.e.., those with 50 to 499 employees) had the greatest sales expectations for the next 12 months, at 4.8% versus 4.0% for smaller entities.

Manufacturers also expect to hire more workers in the next year. Firms plan to increase their employee levels by 2.1% on average over the next 12 months, up from 0.9% one year ago and 1.9% in the last survey. This marks the fastest pace in more than three years (second quarter of 2011). Half of those taking the survey responded that they see positive gains in employment over the next year, up from 46.0%  in September. Still, 45.6%  do not plan to make any employment changes.

On the other hand, manufacturers expect the pace of growth for capital spending and exports to decelerate over the next year. They plan to increase capital spending by 2.3% over the next 12 months, down from 2.5% in September. To be fair, this still represents an acceleration from the anticipated rate of 1.4% reported in December 2013. Looking specifically at this survey, the lower figure resulted from an increase in those predicting declines in capital investment, up from 7.8% in September to 12.6% in December. Still, 31.7% plan capital spending increases of 5% or greater, suggesting that investment data remain largely a positive story.

Of all of the key indicators, capital spending expectations exhibited the largest differences according to firm size. Large manufacturers plan to increase investments by 3.7% over the next 12 months, but that rate falls to 2.5% and 1.0%, respectively, for medium-sized and smaller firms. More than half of small manufacturing businesses anticipate that capital investments will stay the same, which stands in contrast to the 21.1% of larger manufacturers who said the same thing. In fact, one-quarter of large manufacturers are planning to increase capital investments by more than 10%; whereas, just 9.5% of firms with fewer than 50 employees had that level of optimism.

While domestic demand has been relatively strong, exports continued to be soft, reflecting the global economic environment. Indeed, the pace of expected export growth has decelerated for the second straight quarter, down from 1.6% in June to 1.3% in September to 1.2% in this survey. The percentage of respondents predicting exports to increase over the next 12 months declined from 43.4% in the last report to 39.1% this time. As noted in prior releases, manufacturers who expect increased exports over the next year have a more positive outlook relative to those predicting declines or exports being unchanged. In addition, of those expecting higher exports, 78.6% support enacting Trade Promotion Authority.

Meanwhile, manufacturers expect their inventories to increase 1.1% over the next 12 months. This marks the fourth consecutive quarterly increase in stockpiles. While 53.8% of those taking the survey predict inventory levels to remain unchanged, almost one-third predict increased inventories in the next 12 months.

For several quarters now, we have used the NAM/IndustryWeek outlook data in a regression model to predict manufacturing production two quarters ahead (Figure 3). Other variables include current values for housing permits, the interest rate spread, personal consumption and the S&P 500. This model explains 90% of the variation since the data began in the fourth quarter of 1997.

The current model is very encouraging and suggests that manufacturing production should continue to accelerate, growing 3.2% over the next two quarters. In addition to an increased manufacturing outlook, the rising stock market, better housing permits data and decent growth in consumer spending help push this figure higher.