Durable goods orders better than you might think
A combination of a seemingly disastrous December durable goods orders report and weaker than anticipated earnings at U.S. multinationals with currency exposure sent the Dow Jones Industrials down 292 points (1.7 percent) on Tuesday. Microsoft, Procter and Gamble, 3M, DuPont and Caterpillar all reported anemic earnings.
The common thread is that they all have substantial foreign earnings from operations abroad or exports from domestic operations. The dollar has risen about 15 percent on a trade-weighted basis since bottoming out in 2012. When sales abroad are converted back into dollars, fewer dollars are garnered for the same amount of yen, euros, rubles and other currencies. The appreciating dollar is dampening foreign sales, which translates into reduced earnings for U.S.-headquartered multinationals. The group reporting on Tuesday was among those most likely to be hit by the rising dollar, and the trend is likely to continue in 2015.
However, the durable goods orders are better than the headlines might lead you to conclude—certainly, the market got it wrong. Most of the weakness was a correction for abnormally high commercial aircraft orders in the third quarter and the initial signs of weakness in shale oil exploration due to plummeting prices. New durable goods orders declined $8.1 billion (3.4 percent) in December from November. This is the fourth decline in the last five months. However, $7.6 billion of the drop-off was in commercial aircraft. Orders rose at an annual rate of over 34 percent in the third quarter. So, a pullback in commercial aircraft orders was to be expected.
A better measure of business investment decisions is nondefense capital goods orders, which edged down just $0.4 billion in December. Capital goods orders remain at a high level, but couldn’t be expected to continue rising at the same feverish pace as in the second and third quarters of 2014. Excluding orders for aircraft and oil and gas exploration, activity remains strong. A weakening in export orders is hurting capital goods investment, but not by an appreciable amount.
A falloff in orders tied to reduced oil exploration is behind the recent weakness in capital investment plans. Orders at iron and steel mills; mining, oil field and gas field machinery; and other industrial equipment have seen the biggest declines in recent months. Caterpillar is seeing this softness in its order books. Keep in mind that oil and gas exploration represents just 30 percent of investment in nonresidential structures and 15 percent of equipment investment, based on 2012 data. Overall, oil-related investment spending represents 0.5 percent of U.S. GDP. During the Great Recession, when oil prices plunged below $40 per barrel, equipment investment in mining contracted by 30 percent and structures investment fell almost 50 percent.
The bottom line: Businesses make decisions on pulling the plug on a major project faster than adding a new one as capacity constraints become apparent. Orders for oil exploration equipment and supplies are being harmed. However, low oil prices will aid consumer discretionary purchases and manufacturers will commit to add capacity in non-oil related areas over the next few months. Equity markets will realize this at some point.