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What manufacturing doesn't tell you about the US economy: Morning Brief

Sam Ro
Managing Editor

Wednesday, September 4, 2019

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12% of the economy

Manufacturing activity in the U.S. has gone cold.

The Institute for Supply Management’s purchasing managers index fell to 49.1 in August from 51.2 in July. A reading below 50.0 signals contraction in the industry. This was the first contractionary reading since August 2016. A similar manufacturing index from IHS Markit fell to its lowest level in nearly a decade on Tuesday.

However, “ISM is no stranger to false signals,” Renaissance Macro’s Neil Dutta presciently observed back in 2016. While a sub-50 ISM is bad news for folks in the industry and a troubling sign for the economy, these indices need to fall a lot further before they signal that the U.S. economy is in recession.

“A PMI above 42.9 percent, over a period of time, generally indicates an expansion of the overall economy,” the ISM said.

In a note to clients on Monday, Pantheon Macroeconomics’ Ian Shepherdson noted: “It's entirely possible for manufacturing to be in recession—as it is now, and as it was in from Q1 2015 through Q2 2016—while GDP growth runs at 2% or more.”

“Manufacturing now accounts for only about 12% of GDP, 15% of capex, and less than 9% of payrolls,” Shepherdson added.

Over the years, the U.S. economy has shifted from one being driven by manufacturing to one being more driven by services, (which is in much better shape: the ISM non-manufacturing index is very much in expansionary territory).

Still, even if manufacturing is a relatively small part of the economy, doesn’t this data nevertheless say something negative about the trajectory of the overall economy? Not necessarily.

“[W]e warn against putting excessive weight on ups and downs in manufacturing data because the sector now accounts for only 20% of the volatility in overall output growth and just 10% of the volatility in job growth,” Goldman Sachs’ Jan Hatzius said in a report earlier this summer.

“The manufacturing contribution to GDP volatility has fallen with declines in the sector’s GDP share, in manufacturing output volatility and in its correlation with the rest of the economy.”

None of this is to suggest investors and traders should dismiss the data outright. But it’s probably not wise to dump your stocks and head for the hills because one sector of the economy may or may not be sending a bearish signal.

By Sam Ro, managing editor

What to watch today

Earnings

Post-market

  • 5:40 p.m. ET: Slack (WORK): expected adjusted earnings loss of 19 cents per share on $141.55 million in revenue

Other notable

  • 8 a.m. ET: American Eagle Outfitters (AEO); 4:05 p.m. ET: MongoDB (MDB); 4:15 p.m. ET: Palo Alto Networks (PANW)

Economy

  • 7 a.m. ET: MBA Mortgage Applications, week ended August 30 (-6.2% prior)

  • 8:30 a.m. ET: Trade Balance, July (-$53.4 billion expected, -$55.2 billion in June)

  • 2 p.m. ET: Federal Reserve releases Beige Book

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