September 2011 Diesel Index Trend Shows Economic Contraction Possible

Many will think me crazy, but this is one of the most important indexes for understanding what the economy is going to do in the coming months.  Diesel fuel is the blood of the American distribution system – it is moving materials and goods which will be sold at retail level up to several months after the diesel is used.

The Ceridian-UCLA Pulse of Commerce Index™ (PCI), which is based on diesel consumption and designed to mimic GDP, has declined 1.0% in September 2011. Econintersect uses the PCI raw data to help forecast Main Street economy. However, this adjusted index is now showing a 4.3% quarter-over-quarter drop, and is negative 0.2% year-over-year.

There is one problem with year-over-year comparisons – diesel consumption per ton mile is improving at an un-calculable rate.  But on a global basis, this improvement is likely well over 1% and could be as high as 5% per year.  And there have been significant inroads for fuel conservation by placing trailers on higher efficiency railroads.  Therefore, it is trend lines, not specific values, which are important.

And the trend lines are not good.

Both the authors of Pulse of Commerce Index and Econintersect see diesel consumption as an important economic pulse point. Both use the data in different ways, apply different methodologies to analyze the data, and offer slightly different conclusions

According to the economists at the UCLA Anderson School of Economics:

With hopes that the September data would be positive, last month we wrote, “Based on the July and August data, the PCI will likely decline in the third quarter and this suggests GDP growth of zero to 1.0 percent.” Due to the disappointing September number and the consequent third quarter 4.3 percent decline of the PCI, it will be difficult to get a positive GDP number in 2011Q3 — but trucking activity tends to lead the economy, and the effect of the positive growth in the PCI from 2011Q2 lingers on. As such, this makes the PCI-based forecast for third quarter GDP growth equal to zero, meaning just as likely to be negative as positive.

More ominously, the last weeks of September were the weakest, promising more of the same in October.

The positive point of view on this extremely disappointing news is that businesses, in the face of the considerable concerns about growth, appear to be unwilling to restock for a potentially vibrant holiday season at the same time as normal, and they are planning to ramp up inventories late this year, if and when the sales start to materialize. In other words, what we are observing this month is only a weak forecast of future sales, a forecast that doesn’t have to be self-fulfilling. With lean inventories, increases in sales mean increases in production and in jobs.

With the PCI-based forecast for 2011Q3 GDP growth zero, the PCI-based forecast for September Industrial Production is -0.55 percent. Industrial Production is one of the few indices that tracks the official start and end dates of recessions with reasonable accuracy; without a sustained decline of Industrial Production, this slow growth episode we are currently in is not likely to be called a recession by the committee of NBER economists who determine when a recession officially begins and ends.

The transport network in the USA is almost exclusively fueled by diesel – and diesel consumption makes a good proxy for forward economic activity (as transport occurs, on average, one to two months before consumption).

The PCI is modeled using Ceridian’s diesel distribution network to forecast economic growth – primarily Industrial Production and GDP. Econintersect extracts the unadjusted (not modeled) diesel index for its economic model. Graphically, the unadjusted data has a slightly different feel.

What analysts look for are pivot points in the data. Backward revisions in the data also throw wrenches into the works – there was a huge backward adjustment in the July 2011 data. Unfortunately, the data is noisy as demonstrated by the following table of year-over-year growth rates in 2011:

Jan 3.41%
Feb 1.83%
Mar 3.57%
Apr 1.28%
May 2.09%
Jun 2.21%
Jul revised from 1.72% to -1.08%
Aug 2.47%
Sep -0.2%

The three month moving average of year-over-year diesel consumption change remains in a downward trend.  Even considering there is a continuing improvement in the “productivity” of diesel, the effect would not negate the negative trend line (only exaggerate it).  The question is how close this data is to historical recession territory.

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