Why The Manufacturing Recession Doesn't Worry Me

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Includes: RINF
by: Vahan Janjigian, CFA

There is no recession... and yet, there is a recession.

Last week, the Bureau of Economic Analysis increased its estimate for third-quarter GDP growth to a seasonally adjusted annual rate of 2.1%. That's a significant revision upward from its earlier, or "advance," estimate of just 1.5%.

When growth gets down into "the ones," as it seemed to have done for the third quarter, people start chattering about recession - there's something just instinctively worrisome about one-point anything - maybe because the next step down after 1 is zero.

Even at 2.1%, growth could be stronger, but don't forget that it was quite a bit stronger as recently as the second quarter - 3.9%. And since the end of the Great Recession, growth has been negative in only two of 25 quarters. All in all, the economy is doing well, and there appears to be no immediate threat of recession.

That's not to say there is nothing to worry about. In fact, there does appear to be a recession in the manufacturing sector. Just this week, the Institute for Supply Management reported that its closely-watched Purchasing Managers Index (PMI) fell to 48.6 for the month of November, putting it below the critical level of 50 for the first time in three years. That's a serious problem, because any number below 50 indicates contraction. This index is now at its lowest level in almost six and a half years.

Furthermore, several regional manufacturing indicators are also pointing to contraction, including the Chicago Business Barometer and the Empire State Manufacturing Survey, which has been flashing contraction for four months in a row. The Manufacturing Business Outlook Survey (a.k.a. the Philadelphia Fed Report) is registering expansion, but barely so. And it is down significantly from much higher levels at the start of the year.

A prolonged decline in manufacturing can be serious. Because the PMI typically falls during economic recessions, many investors are worried that a recession may be on the horizon. The possibility of recession can never be ruled out entirely, but I'm not too concerned, for several reasons.

First, the PMI has been below 50 for exactly one month in a row. Recessions are typically associated with several consecutive sub-50 PMI readings. So it's too early to sweat. And there have been a number of instances in the past when the PMI dipped below 50 for just one or two months, and then quickly rebounded. These instances did not coincide with recessions.

Second, manufacturing comprises a shrinking component of our overall economy. By some estimates, it now accounts for just 12% of GDP. That's not peanuts, but it is a much smaller portion than the approximately 70% of GDP accounted for by services. And so far, the more important services sector, which also employs many more people than does manufacturing, is holding up quite well. The ISM Business Activity Index was at 63 for the month of October - well above the point of expansion, and slightly higher than it was at the start of the year. The November reading comes out at 10:00 am on Thursday. Economists are expecting something close to 58 - down quite a bit from October's reading, but still comfortably in expansion territory.

And third, I believe that the Federal Reserve remains on track to raise interest rates on December 16. Given the upward revision in third-quarter GDP growth and the falling unemployment rate (including the all-inclusive U-6 measure), it would take something extraordinary to make the Fed postpone an interest rate hike yet one more time. And as my subscribers know, I believe that a quarter-point rate hike, far from being a show-stopper, would actually be a kick in the pants that our economy and markets could well use. This Fed has become extremely adept at postponing the inevitable... but the inevitable inevitably comes.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.