Why production is beginning to recover from the harsh winter

Market Realist

Why this week’s key releases seem more about expectations (Part 2 of 9)

(Continued from Part 1)

What is the Chicago Fed National Activity Index (or CFNAI)?

The Chicago Fed National Activity Index (or CFNAI) is a national monthly index that estimates overall economic activity and related inflation. It’s constructed to have an average value of zero and a standard deviation of one. Since economic activity tends toward trend growth rate over time, a positive index reading implies the economy is growing above the historical trend rate, while a negative index reading corresponds to a below-average rate of growth. A reading of zero indicates the economy is growing at a historical trend rate.

The CFNAI is a weighted average of 85 existing monthly indicators of national economic activity. The 85 economic indicators that are included in the CFNAI are drawn from four broad categories of data: production and income; employment, unemployment, and hours; personal consumption and housing; and sales, orders, and inventories. Each of these data series measures some aspect of overall macroeconomic activity. The derived index provides a single summary measure of a factor common to these national economic data.

What did February’s reading indicate?

The Chicago Fed National Activity Index (or CFNAI) report for the month of February was released on Monday, March 24. The reading came in at 0.14—higher than January’s reading of -0.45, with three of the four categories of indicators making up the CFNAI increasing. In total, 51 indicators improved from January to February (15 made negative contributions), while 33 indicators deteriorated and one was unchanged.

Manufacturing output increases and inflation is likely to edge up over the coming year

The three-month moving average CFNAI-MA3 declined to -0.18 from 0.02 in January, indicating that economic activity in February had grown below historical averages—its first negative reading in six months. This also suggests subdued inflationary pressure from economic activity over the coming year. Production-related indicators contributed -0.26 to the CFNAI in February, up from -0.38 in January. Manufacturing output increased by 0.8% in February after declining 0.9% in January, and manufacturing capacity utilization increased to 76.4% in February compared to 75.9% in January.

Employment-related indicators contract, with a negative contribution to the CFNAI

Employment-related indicators contributed -0.02 to the CFNAI in February, down from +0.11 in January. The unemployment rate increased marginally, to 6.7% in February from 6.6% in January, due to an increase in the participation rate, while non-farm payrolls increased by 175,000 in February after rising 129,000 in the previous month. Civilian employment recorded an increase of just 42,000 in February.

Sales, orders, and inventories increase but consumption and housing indicators disappoint

The sales, orders, and inventories category contribution to the CFNAI increased to 0.06 in February after coming in flat in January. Contributions from the consumption and housing category to the CFNAI increased marginally, to -0.16 in February from -0.18 in January and from -0.14 in December.

Implications for investors

As this is a nationwide index, the readings are based on data from all over the country. It appears that manufacturing has recovered from weather-related sluggishness and production and capacity utilization have increased to make up for shutdowns in January. An increase in production and capacity utilization is likely to impact companies in the manufacturing and industrials sector. One ETF that invests in the manufacturing sector is the Vanguard Industrials ETF (VIS). VIS tracks the MSCI US Investable Market Industrials 25/50 Index. The index consists of stocks of large, medium, and small U.S. companies in the industrials sector in aerospace and defense, construction, logistics, and more. The top ten holdings in the ETF include logistics company United Parcel Service (UPS) and aerospace company Boeing (BA).

For fixed income investors, an increase in production and sales would imply, other factors remaining constant, that the economy is recovering and that the Fed should cease its current economic stimulus policies (its monthly bond purchases, currently at $55 billion and keeping the Fed funds rate low). This would increase interest rates and lower bond prices, other factors remaining constant, and impact fixed income ETFs like the iShares 20+ Year Treasury Bond ETF (TLT) and Core Total U.S. Bond Market ETF (AGG). But as the Fed has indicated several times, its goal of full employment is a key determinant as to when to reduce monthly asset purchases and raise the Fed funds rate. The Employment Index still shows negative readings, which is likely to impact the Fed’s stance.

To learn whether the CFNAI’s boost in manufacturing corroborated with the Conference Board’s Consumer Confidence release, read on to Part 3 of this series.

Continue to Part 3

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