Hanging with the Canary: Japan bearings book-to-bill

by SR on January 26, 2012

  • If you want to keep your finger on the pulse of global machinery shipments, there’s one important data series buried deep in the guts of the machinery stats: the implied book-to-bill ratio for Japan bearings. Not many people look at this, which is a shame – I think it gives a useful heads-up.
  • The recent Japan machinery orders held nothing really actionable and the BB ratio for November 2011 itself fell slightly to 0.97x. November is seasonally a weak month for the ratio and only a few times over the past 20-plus years has the ratio poked its head above 1.0x for the month. Even so, given the long (3-month) lead time of most equipment in which those bearings will be used, it suggests that orders and sales for the spring of 2012 are holding steady.
  • I expect December’s BB ratio to improve a little to 0.99x and for there to be a pronounced pick-up in January and February for production in the late spring and early summer of 2012. The devil will be in the details: we know auto is likely to be strong due to Toyota and Honda ramping up output after the losses incurred during the Thai floods. The question is how much of a contribution machinery demand makes. That’s the swing factor. What we don’t want to see for January is another plunge in the ratio.

Some background

An adult canary typically weighs no more than 25g, about 0.03% of that of an adult male human, which may be why canaries are more easily affected by toxic gas than humans. This susceptibility also explains why, from the end of the nineteenth century, British miners began to use canaries in coal mines. Canaries love to sing and miners knew that when the canary suddenly went quiet it was time to be on the alert for poisonous gas. My canary is called the Japan bearing book-to-bill ratio, and on 12 April 2011 it abruptly stopped singing.

The data that goes into the book-to-bill ratio is part of the the Japan machinery order statistics, which are released in the second week of every month by the Economic and Social Research Institute of the Cabinet Office of Japan. The orders are not super-timely but they are orders and thus innately forward-looking in an industry in which three-month lead times are common. I must admit that I don’t pay much attention to the headline figure, as the category of “machinery” that they use is just too broad for me to grasp. What I do watch is the ratio of orders to sales (the “bookings-to-billings”, “book-to-bill” or simply “BB” ratio) for the bearings segment.

Year-on-year change in Japan bearing orders (%)

The two key things to watch

I look for two things when I scan the BB ratio for bearings.

1) The absolute level of the ratio. As a rule, the BB ratio fluctuates around unity (1.0). If it declines, it suggests that orders are growing less quickly and sales, which in turn implies that the current level of sales will decline going forward. If the BB ratio rises, it should mean that orders are increasing more rapidly than sales and that we can reasonably expect sales to follow in the near future. So a ratio of 1.05x would usually be much more favourable than 0.95x. On 12 April 2011 the ESRI released orders for February 2011 (i.e. from before the Tohoku earthquake) that showed a BB ratio of 0.93x – very poor indeed.

2) Volatility in the ratio. In a stable market the month-to-month moves should not be that large. A move from 1.05x to 1.02x is no cause for concern, but a move of (for example) 0.08x would be very large. The BB ratio can go for months without any significant moves. Between late 2002 and late 2007 there were no worrying negative month-on-month moves and quite a few large positive moves. That’s the sign of a happy market and of course it reflected the ‘golden era’ of Japanese auto OEMs in the US market during that period. The February 2011 BB ratio moved down from 1.01x in January to 0.93x in February, which is a very large move compared to historical data.

Japan bearing book-to-bill ratio

What does it all mean?

Panic is perhaps too strong a word, but when I saw that 0.93x ratio back in April my heart sank into my boots. I rechecked my data and the calculations, but there’s not much to check and no parameters to fiddle with. It soon became clear that this was simply a very, very bad figure. At that time, the BB ratio had only dipped below the 0.95x level a total of 16 times during the previous 23 years and 8 of those months were during the financial crisis. So this figure hinted at a serious slowdown or potentially even a second global crisis. Note that this order figure predated the Tohoku earthquake by a month.

The underlying logic here, and the reason that we should pay attention, is that any machinery above a certain level of complexity uses bearings, from the fans in your refrigerator to wheels in your car to the steam turbines in your local hydroelectric power plant.  Japan’s bearing companies may not be well-known by investors outside Japan but they are globally very competitive, especially in the automotive and machinery sectors. If their orders are falling, this likely reflects a global slowdown in machinery builds.

I called my clients that day in sombre mood and wrote a note. After our daily research meeting another analyst came up to me at the coffee machine. “So, how worried should we be about these bearings of yours?” he beamed. As it turned out, we should have been very worried. From that day to the end of 2011 the TOPIX market index fell another 13%, making a 20.9% decline for the year. “Ah” you might say “but that was just Europe and China slowing and all the other macro noise, wasn’t it?” and you’d be mostly right. What I’m arguing is that the sudden slump we saw in the BB ratio reflected those macro issues, caught them early and put them in concrete form in front of us.

Not magic

In case it sounds as if I am attributing magical powers to the BB ratio, let’s be clear that I regard the BB ratio as just another part of the informational puzzle, albeit a large and useful piece. Realistically it should only be interpreted in the light of its immediate context. Consciously or not, an experienced fund manager will probably use a number of heuristics to inform his or her view on the market. This deserves to be one of them.

Year-on-year change in Japan bearing orders (%)

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