What These Two Indicators Are Telling Me
This week’s manufacturing data confirmed that the cyclical recovery is indeed
picking up steam. Industrial production rose by .4% last month with output
showing its biggest increase in over 3 years. And, the Philly Fed’s
manufacturing index also surged higher, posting its biggest increase in 7 years.
These improvements in manufacturing activity are not only important for the
labor market but also for corporate profits.
Typically, when businesses are feeling optimistic about future demand for
their goods and services (and therefore corporate profits resulting from
revenues), they purchase new equipment in order to produce sufficient goods to
meet increased demand–which is currently taking place as evidenced by the
marked improvement in this week’s data.
Can these improvements in the economy and the stock market continue?
Two forward-looking indicators of industrial activity suggest that
manufacturing activity and the S&P 500 both have further upside.
The Journal of Commodities Industrial metals index (which is comprised of
copper, nickel, zinc, aluminum and lead) continues to perform well. In fact,
today it closed at a three-year high. The reason why this bodes well for
equities is that industrial metals are an integral component in the majority of
durable goods. And, demand for durable goods typically increases alongside
corporate profits, which makes sense since companies usually invest in new
equipment to manufacture additional goods to meet increasing demand. As can be
seen in the chart below, there is a strong correlation between the JOC index and
forward earnings.
The Conference Board Index of Leading Economic
Indicators, which has been a very accurate forward indicator for industrial
activity, has been up sequentially since April, suggesting that a meaningful
rebound in production has more upside. As can be seen in the chart below, the
index has led production activity by six months and is now at levels not seen
since August 2002. At the same time, industrial production only recently started
to turn up.
