Stansberry Research

Empire Manufacturing Data Show Costs Keep Dropping

C. Scott GarlissStansberry NewsWire

Manufacturing data are signaling a further slowdown in inflation...

Earlier today, the Federal Reserve Bank of New York released its Empire State Manufacturing Survey for January. The overall number was awful. The headline reading plunged to -32.9 compared with the expectation for -8.7 and the prior month's -11.2.

(A negative reading tells us manufacturing business in the region is contracting, while a positive reading indicates it's expanding.)

The result was nearly four times worse than what Wall Street had been anticipating. In fact, it was the worst number we've seen since May 2020, when the economy was struggling due to COVID-19 social-distancing restrictions.

Now, we want to pay attention to New York because it's the third-largest state behind California and Texas in terms of its contribution to national gross domestic product. According to the Bureau of Economic Analysis, the state accounts for roughly 8.1% of economic output.

And these numbers point to increasing weakness in the domestic economy...

Every month, the New York Fed sends questionnaires out to 200 regional manufacturing executives. They're asked about the state of current business in addition to their outlook for activity six months down the road.

For January, the most notable changes were the declines in new orders and shipments. The former went from a slight contraction to a very sharp one, while the latter switched from positive to decidedly negative. At the same time, the unfilled orders index fell further, indicating companies are working through their backlogs.

The only category that saw an improvement is inventories. Now, when overall output is slowing, rising inventories would seem like a bad thing. However, considering the supply-chain problems experienced over the past few years, an inventory rebuild will help the long-term outlook for price stability.

As evidence, let's take a look at the numbers we care most about... prices paid and prices received.

These two indexes are key measures of inflation growth. And, if we're going to search for signs of looming changes in Fed interest-rate policies, these measures will be one of the first places to check.

The prices paid index tells us what manufacturers are shelling out for raw materials to produce goods... We can think of it relative to the U.S. Bureau of Labor Statistics' ("BLS") Producer Price Index ("PPI"). In the January survey, prices paid dropped, which means that manufacturing costs fell. Take a look at the following chart...

In January, prices paid came in at 33 compared with December's 50.5 and April's all-time high of 86.4. The manufacturing cost index hasn't been this weak since November 2020. The overall trend still remains lower compared with the 12-month average of 62.1.

Next, take a look at the prices received index. This tells us what companies are collecting for finished goods... in other words, what it's costing individuals to buy something. So, we can think of it relative to the BLS's Consumer Price Index ("CPI")...

This month, the measure dropped to 18.8 from December's reading of 25.2 and March's all-time high of 56.1. It hasn't been this low since the start of 2021. January's number is also far below the 12-month average of 35.9.

As we've said, both measures are leading indicators of the direction of inflation. And as we can see from the above charts, the readings for prices paid and received have a tendency to peak before or right around the same time as the PPI and CPI.

However, companies are growing optimistic that conditions will improve in the next six months. The business outlook index rose from 6.3 in December to 8.0 in January. Just a couple of months ago, in November, the outlook for future activity was worse than it had been during the pandemic.

Manufacturers also expect production costs to fall. And they should be able to pass those savings on to consumers. That would indicate a continued easing of consumer inflation growth well into summer.

Money managers investing for eight to 12 months down the road want to see this trend. It speaks volumes to them about the potential for an economic rebound...

You see, if inflation growth slows, it means prices for goods are stabilizing. This tells the Fed that its rate hikes are working, which means it can stop raising them. And at this rate, we may even see costs start to drop by the middle of 2023. This could give the central bank room to consider cutting rates.

If we were to see a slowdown in inflation and the Fed potentially pausing rate hikes – or even cutting rates – households would feel less pressure to save money in anticipation of future cost increases. Instead, they'll feel more confident about spending it again.

Institutional investors realize the outsized economic growth experienced during 2021 due to massive amounts of stimulus is unsustainable. They want to see economic activity revert back toward the mean. That way, they can get a better idea of what the true supply and demand picture looks like.

Then, as analysts and portfolio managers have a better sense of what companies' future earnings look like, they can place fair-value multiples on stocks. This will help to remove asset managers' unease toward the market.

In turn, we should see money going back to work buying up high-quality assets and rallying the S&P 500 Index.