Slowing Industrial Production Could Hurt Financial Markets

Truck Assembly Plant

Source: Arizona Daily Star

U.S. industrial production for the month of October 2018 rose 0.1 percent versus September:

Mining and utilities dragged on the US industrial sector, prompting it to expand at a slower than expected pace in October even as manufacturing chugged along. Industrial production – a gauge of output at factories, mines and utilities – edged up 0.1 per cent month-on-month in October, according to data from the Federal Reserve. The reading missed expectations for a 0.2 per cent increase, according a Refinitiv survey, and followed a downwardly-revised 0.2 per cent increase in September.

Industrial production was also lower than the 0.2 percent gain reported in September. Hurricanes hurt industrial production in September and October, though the impact is estimated to be less than 0.1 percent per month. Manufacturing output rose 0.3 percent, its fifth consecutive monthly increase. The indexes for mining and utilities fell 0.3 percent and 0.5 percent, respectively.

Total industrial production for the month of October was up 4.1 percent Y/Y. I wonder if single-digit yearly gains in industrial production are a thing of the past. Capacity utilization for the industrial sector was 78.4 percent – 1.4 percent below its long-run average. After trillions in stimulus and tax cuts to spur the economy, capacity utilization is still below its long-run average. It fits my theory that most of the benefits of the stimulus packages went to the wealthy, who had a lower marginal propensity to consume. The stimulus may not fully trickle down enough to spur further economic growth.

Has Industrial Production Peaked?

Motor vehicle assemblies appear to have peaked; motor vehicle assemblies were 10.8 million in October 2018, down over 4% versus September 2018 and flat Y/Y. This was also well off the post-financial crisis peak of 12.6 million set in July 2015.

Auto Assemblies For October 2018

Source: St. Louis Fed

Manufacturing activity continues to melt up, but could be held overshadowed by dismal activity in mining and utilities.

Manufacturing Production October 2018

Sans more government stimulus, this could be as good as it gets for industrial production and the economy in general. The Federal Reserve is hiking interest rates and continues to unwind its $4 trillion balance sheet – these are anti-stimulus measures.

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How will Financial Markets React?

Financial markets have been volatile over the past month, particularly within the technology sector. Stocks like Facebook (FB), Apple (AAPL) and Netflix (NFLX) performed well when capital was flowing into the overall financial markets. Momentum stocks also tend to fall harder when markets falter. President Trump and others have called for the Fed to slow down the pace of interest rate hikes. If the Fed hikes rates in December and intimates it will slow future hikes, then the market could rally.

Otherwise, it could take solid economic data to spur financial markets. I do not think that will happen. Dismal industrial production could hurt names like General Electric (GE), whose industrial businesses are dependent upon industrial production. Falling motor vehicle assemblies could hurt auto stocks. A derivative of autos could be BlackBerry (BB), whose QNX technology helps protect connected cars from hackers. If auto assemblies continue to fall, then it could hurt a key revenue source for BlackBerry and other technology names dependent upon growth in connected things.

Conclusion

At some point, industrial names and could trade down based on dismal industrial production growth. That does not bode well for stocks. Investors should brace themselves for more volatility in financial markets.

Disclosure: I am/we are short GE.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.