Justin Lahart
This morning's report from the National Association of Purchasing Management showed a manufacturing sector that remains deeply mired in recession. The Purchasing Managers' Index, which is based on a national survey of purchasing executives, came in at 43.6 for July. The index has now been below 50, signaling contraction in the manufacturing economy, for a full year.
Yet within the report there was some cause for hope. The Inventories Index slipped to 35.8 -- the lowest it's been during the current downturn -- indicating that manufacturers are rapidly working down excess stock. In response to a special question, 19% of the purchasing managers said they thought customers inventories were too low, while only 9% felt they were too high. "The cupboard is bare," says Bank One chief economist Diane Swonk of manufacturers' inventories, "and we have to start replenishing it." The rate at which traditional manufacturers have cut inventories has had a lot to do with the depth and speed of the manufacturing slowdown. For example, companies like General Motors and Ford reacted very quickly to slowing demand, cutting production and lowering inventories last fall. Because they were working off what they already had, the automakers ended up ordering fewer parts than they were using. This translated into tough times for their suppliers, their suppliers' employees, their suppliers' suppliers, and so on. Many economists referred to this as a just-in-time inventory correction: Technological advances that allowed companies to rapidly analyze demand data had, in effect, caused the manufacturing economy to slow in Internet time. When demand picks up, however, the process may quickly reverse itself. Manufacturers, seeing that they overshot on reducing inventories, will work to rebuild stocks -- ordering more parts than they're using. Their suppliers will see increased demand, step up production and hire back workers. Such an accelerator-effect is typical as the economy comes out of a slowdown, but it's possible that it may come more quickly than many economists expect. After all, if manufacturers responded to the downturn in demand so quickly, what's to keep them from responding to an uptick just as fast?Chips and Dips
Semiconductor stocks were on something of a tear today after Merrill Lynch's chip analysts said that the worst of the downturn was behind the sector and upgraded a raft of stocks. The analysts opined that the better companies had set the bar on the quarter low enough that they wouldn't have to issue warnings, that year-on-year revenue growth rates are on the verge of bottoming and that valuations are good. Merrill's brokers got on the horn with clients, CNBC gushed about the upgrades and the Philadelphia Stock Exchange Semiconductor Index was lately up 6.9%. In the past, when things have turned around for chip companies, their stocks have made big jumps higher. As a result, investors and analysts are keen to call the bottom on the sector. To the winner, profits and glory. The problem is that such rewards may prompt many to be, um, early. There are plenty of reasons to think that waiting to go heavily into the chips might not be a bad idea, according to J.P. Morgan strategist Tom Van Leuven. "We'd prefer to wait until we have some more clear indications that demand was actually picking up and the prospects for semiconductor earnings were improving," he says. "We're skeptical about these brief rallies we've been seeing in the group." One of the chief indicators the J.P. Morgan strategists look at for the semiconductor sector is capacity utilization. Historically, when the capacity utilization rate begins to rise, it's been a great time to buy chip stocks.| When the Chips are Down Philadelphia Semiconductor Index vs. Semiconductor Capacity Utilization |
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| Source: Baseline; Federal Reserve. |
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