JOYG Joy Global Inc. (MM)

Total Industrial Production rose by 0.7% in October, much better than the 0.4% rise that was expected. However, September was revised down to a decline of 0.1% from being up 0.2%.

The Industrial production numbers are often distorted by Utility Output, which is often affected by the weather as much as it is by economic activity. To get a sense of what is happening in the economy, it is worth looking at just manufacturing output.

Factory output rose by 0.5%, up from 0.3% in September (revised down from 0.4%) and 0.3% in August. Year over year, total production is up 3.9% while factory output is up 4.1%. That is a healthy increase on both counts.

Utility production was once again weak, with a decline of 0.1% for the month, but that is a much smaller decline than the 2.0% it fell in September, and that came on top of a 3.1% plunge in August. Year over year, utility output is up just 0.1%.

The third area covered is mining, and that has been the real star. It saw a 2.3% increase for the month, more than reversing the 0.5% decline in September. In August, mine output rose 1.1%, and it is up 6.0% over the last year. This suggests that we are off to a good start for the fourth quarter. The downward revision to the September numbers does rain on the parade a bit, so don’t read too much into the better-than-expected level.

Capacity Utilization

The other side of the report is Capacity Utilization. It, too, was better than expected, rising to 77.8% from 77.3% in September (revised down from 77.4%). It was expected to be 77.7% and was just 75.7% a year ago. As with industrial production, utilities can distort the picture due to weather.

Factory utilization rose to 74.4% from 75.1% (unrevised) in September and 74.9% in August. A year ago it was 73.0%. However, on both counts we are still well below the long-term average levels of 80.4% overall and 79.0% for just factory utilization. Then again, we have made a very big comeback from the depths of the Great Recession, when total utilization hit just 67.3% and factory utilization was as low as 64.4%.

Utilities have been very weak in terms of utilization with just 77.5% of capacity used, down from 77.7% in September and 79.3% in August. A year ago utilization of power plants was 79.2%. The long-term average is 86.6%. We actually have a substantially lower rate of utility utilization now than we had at the worst part of the recession, when it was 79.2%.

Mine output is straining the limits of its capacity (these numbers NEVER get close to 100%) at 92.7%, up from 90.7% in September and from 89.3% a year ago. Its long-term average is 87.4%. Oil and gas output is included in the mining figure, and much of the strength is due to the shale output of oil (North Dakota) and gas (many states, but especially in the Marcellus Shale of Pennsylvania and West Virginia).

The rise in capacity utilization has faced the headwind of growing capacity. Total capacity is up 1.1% from a year ago; not too long ago it was falling. The growth in capacity has been stronger in both the utilities -- up 2.2%, and mines, up 2.1% -- than it has been for factories, up just 0.7%. Still even 0.7% growth is not awful.

Clearly it is easier to fully utilize capacity if there is less of it, but growing capacity is a good thing. Falling capacity means that factories, mines or power plants are being closed for good.

A Highly Underrated Economic Statistic

Capacity Utilization, particularly factory utilization is one of the most underrated economic statistics out there. A good rule of thumb is that 80% represents a good healthy economy. If it rises above 85%, the economy is overheating, and there is a real and present danger of inflation accelerating. Thus the Fed needs to cool things down by raising interest rates or taking other steps to tighten monetary policy.

A level of 75% is normally associated with a recession. The 67.3% level for the total and the 64.4% for factories at the bottom of the recession were both record lows (the data goes back to 1967) by a wide margin. The previous record lows were both set in December 1982 at 70.9% in total and 67.9% for manufacturing.

In other words, while we have come a very long way from the bottom in June of 2009, we are still operating at depressed levels. The graph below (from http://www.calculatedriskblog.com/) shows the long-term history of capacity utilization, both in total and for just Manufacturing. Note that the levels we fell to were much lower than in previous downturns, but the recovery has been far more rapid than in either of the last two downturns, and more in line with the sort of recoveries we saw in the 1970’s and following the 1982-83 downturn.

Both mines and utilities tend to have a lot of operational leverage. This data suggests overweighting domestic oil and gas producers, as well as domestic mining companies, and underweighting utilities. Utility dividends are attractive, but these days there are lots of places you can find a decent dividend yield other than in the utilities.

I would be avoiding companies like American Electric Power (AEP), Dayton Power and Light (DPL), and El Paso Electric (EE). On the other hand, the strength in mine capacity utilization is very good news for the makers of “picks and shovels” for the mining industry like Joy Global (JOYG) and Caterpillar (CAT).

The same would be true on the oil and gas side. Names like Key Energy Group (KEG) and Pioneer Drilling (PDC) are worth taking a look at.

Overall, this was a very good report.

 

 
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