Global Manufacturing Leads the Recovery

The manufacturing sector suffered the worst decline throughout the global economic slowdown. However, recent economic data points to a pick up in activity - but areas of caution remain.

Let's start with Australia. The country's prime location and export dependency make it a key indicator for the projected trade activities of Asian giants. Australia's manufacturing sector is off to a slow start in 2011 with PMI largely unchanged and below 50 - indicating a contraction in activity. Firms remain cautious, resulting in inventory declines and lower ordering numbers mainly in construction. The cautious attitude comes amidst a 'fading' resource boom. China's demand for Australian resources is falling off a bit, below expectations of its assumed positive sloping demand curve. We'll get back to China later in this post. 

Here in the US, the manufacturing sector is rising at its fastest pace in seven years. The ISM report shows employers' positive outlook on future hiring. ISM numbers are currently at 60.8, well above the critical 50 mark, indicating strong growth. The Fed will continue its $600 billion in asset purchasing (QE II), but ease down in the long run, so long as employment and manufacturing follow an upwards path.  

Another important indicator is the housing market, which is still on the decline. The US Commerce Department reports that construction spending fell 2.5% in December 2010 - its lowest level in this decade of convex activity.

There is good news on the corporate front. US companies are reporting stronger financial standings, with positive earnings forecasts for the early quarters of 2011. The picture looks even better in the small business sector. According to Thompson Reuters/Pay Net Small Business Lending Index, borrowing by small businesses is up for five months straight. The auto industry is led by General Motors (GM) and Ford, reporting an increase in sales by 22% and 13% respectively. A remarkable comeback for GM after its tumultuous financial standing. The US auto companies are expected to pick up hiring (especially in the Detroit area; currently facing near 12% unemployment). GM and Ford have since re-focused strategy towards lower costs and more fuel efficient innovation, equating to a demand for talent. 

The US economy is up 3.2% on an annual basis - from the last quarter in 2010.  

Europe manufacturing is also booming, mainly led by Germany. For a candid visual analysis of January PMI graphs in the Euro-zone refer to my colleague Edward Hugh's Facebook blog. 

Despite strong ISM numbers in the US and Europe, there are still slight problems ahead. For one, Australia remains sluggish, which is not a good sign about direct demand from emerging markets. It's clear that something is up in the East. 

Here's the problem. The global wave of inflation = higher input costs = pressure on profit margins. Businesses will need to find ways to absorb this before domestic consumers start to heavily economize. The high input costs begin in Asia. China has some structural problems - domestic inflation and a shortage in young factory workers. The Asian giants that specialize in the physical manufacturing of export goods to the west (such as Thailand and Vietnam) meet a block in the supply chain when the first batch of goods arrive in China. The lack of factory workers who are demanding higher wages to fend off inflation, create this inevitable input cost on the finished product. This in turn creates higher priced goods in the US and Europe. 

On the other side of the trade equation, the Chinese government plays the game well. Domestic inflation is sending the Yuan higher, which means greater purchasing power for more imports. However, the rising value of the Australian Dollar makes resources goods down under less attractive. So, we can give Australia some slack in our model that measures the direct conditions of Asian demand. 

I say this is a short term problem that has a lot of room for correction. Latin America also has a problem of rising currency values, but governments have worked to push the value lower to make export goods attractive for Chinese demand (hence the currency war). And to fix China's input cost problem with its shortage of young factory workers - look towards India. A nation with a large population of young workers, mainly working in outsourced industries from the West, but also capable of picking up factory work to keep the Asian supply chain network in tact.