Don’t sleep on durable goods—they’re a leading indicator for corporate nerves.
KEY TAKEAWAYS
MY HOT TAKES
We got to move these refrigerators—we got to move these color TVs. I remember sitting in an insanely large lecture hall with my legendary post-Keynesian Econ Professor Alfred Eicher (he is a legend, look him up 😉). He was walking around on the stage in front of the hall, speaking into a microphone. And then I heard it for the first time, the term: durable goods. I thought, “what on earth is he talking about?” I wrote it in the margin of my spiral notebook and circled it several times in green ink. Back then, a Bic multi-colored pen was necessary for taking notes in economics classes. Eichner said it again and again and I know that I wasn’t the only Freshman wondering what he was talking about. Side note: questions were not allowed in lectures back then–you would have to wait to ask one of his teaching assistants during a recitation session. Thankfully, he finally defined durable goods as things that would hurt if you dropped one on your toe. 🤣 Yeah, that’s economics humor for you.
I suppose dropping a refrigerator on your toe would indeed hurt. The real definition for a durable is one that lasts more than 3 years. But durable goods go beyond household appliances. They are typically big-ticket items like automobiles, aircraft, trucks, industrial and farm machinery, construction equipment, computer servers, semiconductor manufacturing equipment, telecom routers, boilers… the list goes on, but I think you get the picture. But DID you get the picture? These goods are predominantly high-cost items and they serve industry. You may have also noted that I hid those high-tech ones in the middle. They are becoming increasingly important these days, but in reality, all are important in assessing strength in industry.
Let’s take a step back. When we make purchases in the home, we think about things carefully. Can we afford them? Would we be better off saving the money for a rainy day? How badly do we want these items? Do we really need them? You do that, right? I am sure you do, but there is probably an emotional factor in it too. That has a lot to do with your confidence and sentiment. Don’t worry, I am not going to perseverate on consumer confidence today. No, that is for next week.
Today, let’s think about purchasing manager decisions at companies. Now, I am not going to deny that emotions play a role in corporate management decisions. Having worked in Mergers and Acquisitions at one time in my career, I have DEFINITELY witnessed emotional management decisions. 😉😜 That aside, for the most part, decisions about whether or not to purchase new aircraft, oil rigs, injection molding machines, laser cutters, or an EUV lithography machine (ASML sells these for $150,000,000) are made with very careful, non-emotional analysis. The decisions are likely based on a form of Net Present Value, which quite literally factors in all expected future cash-based returns from the purchase. That said, if a manager expects returns to be large in the future, the NPV is likely to be greater than zero (which means “yes” for finance folks), or even far greater. Stay with me. If management is confidence that they can achieve strong returns in the next three plus years, those future cash flow forecasts will be bigger.
Can you see where I am going with this? When companies are expecting tough times, their analysis is likely to cause them to forego these larger… er, durable goods. These analyses are very complex in practice, where managers come up with distributions of potential outcomes in the future and use them to run simulations to determine probabilities of value. In that case, if you were highly uncertain about business conditions next year and the two years beyond, the broad distributions would likely yield some very wild forecasts that would range from great success to epic failure, versus a forecast that is positive with a high confidence level. I know, you are thinking “wo, wo, wo Mark, slow down.” Ok, it boils down to this. If companies are worried about economic conditions going forward, they are likely to forego capital expenditures, AKA durable goods.
Given the current economic climate where edge-case scenarios have become the norm, all of us are attempting to assess where the economy may be later this year and even next year. Will companies literally stop buying equipment? Will they stop hiring, or worse yet, will they lay off employees? Well, durable goods purchases won’t tell you about employment, but they will tell you a lot about corporate sentiment. A lack of it can be a leading indicator for future employment problems. More directly, a decline in durable goods orders directly impacts GDP. Specifically Private Nonresidential Investment, which makes up roughly 15% of GDP. But there are even more tangible impacts to the economy. For example, if a company puts off the purchase of a Gas Turbine, General Electric would earn less. “Less,” as in as much as $50 million less!
Can you see why real economics nerds care about obscure numbers like durable goods orders. Yesterday’s release showed that while the overall number surged due to aircraft orders, business equipment and core capital goods orders were subdued, suggesting that companies are becoming cautious. Next week we will get another similar indicator with the ISM Purchasing Managers’ Indexes. You should pay attention to these to avoid portfolio missteps. Those pains can be far more painful than dropping an air conditioner on your toe.
YESTERDAY’S MARKETS
Stocks rallied yesterday as investors couldn’t resist recently-bloodied tech shares, made sweeter by the President’s latest, more moderate, trade overtures. The S&P 500 managed to escape the gravity of the correction zone having climbed above its recent low by 10.07%--yep, that extra 7 100th percent pushed it over the crest. Ten-year Treasury Note yields eased by 6 basis points in a further reversal of the recent surge.
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