factory: Gloom on the factory floor will soon give way to cheer

Two data releases came out last week that told seemingly conflicting stories about the state of the economy. The ISM Manufacturing survey , a key bellwether of factory-owner sentiment, dipped into contraction territory for the first time since May 2020. At the same time, the Personal Income and Outlays report put out by the Bureau of Economic Analysis showed that spending on goods is picking up, with monthly growth on an inflation-adjusted basis clocking in at its fastest pace in a year.
How can factory owners be so negative when consumer spending growth is accelerating? The answer lies in the supply chain and how improvements over the past several months have affected producers, retailers and consumers differently. The adjustment is going to take a few more months, but manufacturers are in line to benefit just as consumers are now.
For consumers, smoother-flowing supply chains are all-around great news. Products are now more likely to be in-stock, shipped in a reasonable amount of time, and, depending on the product, possibly even cheaper. That all supports increased consumer spending. I’m more likely to buy something if a retailer actually has it available. And as gasoline and used-vehicle prices have fallen over the past several months, consumers have money left over to spend on apparel or electronics.

For retailers it’s been more of a mixed bag, but should be good news over time. Nike Inc. is a good example of the roller coaster retailers have experienced with supply chains this year. On-hand inventory surged in its most recent earnings report. Supply-chain delays earlier in the year meant they didn’t receive seasonal merchandise until it was past peak selling season, and then after shipping times normalized, they ended up receiving holiday-season merchandise ahead of schedule — a sort of supply-chain double whammy.
Going forward, normalized supply chains should mean lower freight costs and more reliable production and shipping times for retailers, but in the meantime they have an inventory mess to sort out.
It’s that glut of inventory and, interestingly enough, improved shipping times that have manufacturers so pessimistic about the near term. Various retailers have talked about holding too much inventory, or the wrong kind of inventory, since this spring, but this month’s ISM survey was the first one to show that in the aggregate, customer inventories are back to balanced rather than too low like they have been for the past two years.
At the same time, delivery times have sped up for two consecutive months, a big shift from 2021 and the first half of 2022 when backlogs and clogged ports led to longer and longer delays in the movement of goods. This matters because if it has been taking months for my orders to arrive and now it only takes a matter of weeks, I can put off replenishing my inventories until I actually need them. This is creating a one-time air pocket in demand as sellers are no longer worried about being undersupplied or dealing with the impact of supply-chain delays.
The Packaging Corporation of America, which makes the kind of corrugated packaging that goes into shipping e-commerce orders to households, spoke in October about how one of its large accounts went from having its business being up 3% to down 50% as it shifted to working down its inventory levels.
There are a couple different ways this situation can resolve itself over time. Perhaps October was a head fake for consumer spending and it slumps over the next few months, validating the negativity of producers. But with another strong jobs report last week and gasoline prices down 40 cents a gallon over the past month it’s hard to see why that would be the case.
The more likely possibility is that it will take a little while longer for all sellers to pare down their bloated inventories, and then retailers won’t be in a hurry to replenish since they won’t have to worry about lengthy delays anymore. But over time, it’s consumer demand that will dictate activity levels at factories.
So factory owners are understandably pessimistic based on what they’re seeing in their orders at the moment and the general fears around recession heading into 2023. But they need to give it a little more time. Consumption will probably remain resilient, and we’ll see factory orders pick up in the first half of next year.
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