Amid the stock market chaos of the last full week in August, the Commerce Department issued a bit of good news. Seasonally adjusted orders for nondefense capital goods (excluding aircraft) increased by 2.2% in July to just under $70 billion. That represents the first time that value has topped a 2% increase since June of 2014. Defense-related capital goods showed an even higher percentage increase of 22.3% as spending rose to $11 billion. New orders for all durable goods improved by 2.0% to $241.1 billion.
Higher spending on capital goods indicates further economic growth by acting as the precursor for increased consumer spending. Manufacturers are not going to invest in capital equipment and new items to improve capacity unless they anticipate a higher demand for their products. That effect ripples all the way through the supply chain from raw materials to the final consumer product. Consumer spending accounts for approximately two-thirds of economic growth as measured by the Gross Domestic Product (GDP). Spending increases on the defense side do not directly affect consumer demand, but they do improve the income of defense-related companies and provide their employees with jobs and discretionary income.
So does this report mean that good times are ahead even with all the chaos on the stock market? Not necessarily. The Commerce Department report is based on the results of the Manufacturers' Shipments, Inventories, and Orders Survey from July, before the August stock market turmoil ever took effect.
GDP numbers support increased economic growth as second quarter GDP was revised upward to 3.7% — but again, that is lagging information and not leading information. For the expansion to represent a true change in the business cycle and not a momentary surge, capital spending needs to increase for multiple months in a row to show continued optimism amidst the volatility. While July's 2.2% follows up on the 1.4% increase in June, there have not been three successive months of gains within the last two years. Measures of consumer confidence have been equally volatile, making it difficult for manufacturers to feel comfortable with expansion.
The capital goods numbers seem disconnected from the broader market right now, because the market is focused on broad future conditions. Much of the economic downturn is related to China and their slowing economy. A company that is dependent on China for much of their sales may be expanding at exactly the wrong time, while a company making consumer goods for the U.S. market may well be justified in their expansion. It requires case-by-case analysis.
In essence, an increase in capital goods spending is a good economic sign, but must be taken in the context of other economic data and with respect to trends and momentum. Increased capital goods spending contributes to an improved stock market, but does not translate directly to it.
Similarly for consumers, increased capital goods spending should indicate increased demand, and could affect prices and inflation depending on how fast supply is changing with demand, but it does not directly correlate to higher consumer prices. Pricing depends on how well individual companies have predicted demand for their goods and their production costs and acted accordingly.
Keep capital spending in context, and look at the likely impact on your individual holdings instead of making investment decisions on broad economic data. As for consumer spending, keep it simple. Buy it if you need it and can afford it. Your individual economic situation and the interest rates you have to pay on any borrowing are more important than speculation on refrigerator or automobile prices.
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