A Manufacturing Contraction – Now What?

According to Tuesday’s PMI release from the Institute of Supply Management, the manufacturing sector is officially in contraction. The 49.1% reading is the first below the 50.0% flat-line in 3 years and is clearly trending in the wrong direction, but what does that mean for the economy and for stocks?

The Manufacturing Purchasing Managers Index has existed for more than 50 years, so we have a decent data set to work with. The PMI has signaled contraction during each of the 8 recessions (grey) since 1960. But getting below 50% hasn’t been enough. There have been 9 periods (red) where the manufacturing sector contracted but the overall economy continued to grow. If the past is any guide, we’ll see readings in the low 40s if this contraction in manufacturing spreads to the rest of the economy.PMI.PNG

The Business Employment component of the survey fell below 50.0% during August as well. Like the PMI, though, we’ve seen lower results even during the current economic expansion, and a recession would likely warrant this measure falling into the 30s.Employment.PNG

The weakest areas of the ISM Report are in orders. New Orders are at their lowest since 2012, a level that has only been reached a handful times outside of recession.New Orders.PNG

And if you’ve been following trade developments over the past 2 years, it shouldn’t be too surprising that Export Orders are weak. Still, the August drop marks the second-worst period since this survey began in the late 1980s.Export Orders.PNG

Historically, the ISM Survey has been a pretty good coincident indicator for both S&P 500 revenues and trailing 12-month price performance. True to form, stock market returns have been below average for much of the last year. Should we continue to see the PMIs fall, it wouldn’t be surprising for equities to decline as well.PMI vs SPX

On a brighter note, the ISM Non-Manufacturing survey results from Thursday improved to 56.4% in August, and hasn’t been below 50.0% since 2009. More often than not, the two surveys (Manufacturing PMI and Non-Manufacturing PMI) trend together, so we shouldn’t expect the divergence to last long. As long as they’re in conflict, though, the overall direction of growth will be cloudy. I’ll be keeping a close eye to see which of the two trends wins out.

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