German Manufacturing Back In Recession - This Doesn't Bode Well For The Eurozone Economy

by: Tim Worstall

The German manufacturing economy might be sliding into recession.

Given the size of that within the German economy, then the eurozone, this does not bode well for either of the two larger economies.

It's time to at least think about exiting eurozone equities, maybe even to start positioning for a recession in bonds.

What's the Problem Here?

Macroeconomic factors will overwhelm near any investment plan based upon an individual stock or bond. Thus we need to be clear on the general direction of the economy before making such specific plans. The macroeconomic indicators we've got coming out of Germany are showing the signs that we should be nervous. It's a good time to ponder relocating investment plans outside the eurozone or even to think of bonds not equities.

What's Today's Indicator?

A PMI is a purchasing managers' index. Simply put, if you want to know what will be made next month go ask the people who are buying the things to make it from this. So, if you know what purchasing managers are buying to produce from you've a good idea of what next month's output is. This is then cast as an index. A reading of above 50 means output is expanding, less than 50 contracting.

What we'd very much prefer not to see is this:

Germany manufacturing PMI from IHS Market

(German manufacturing PMI from IHS Markit)

As they explain:

Germany's manufacturing sector remained stuck contraction in May, according to the latest PMI® data from IHS Markit and BME. Though rates of decline in output and new orders eased, employment fell the most in almost six-and-a-half years. A sustained decline in demand for inputs meanwhile contributed to a fall in purchasing costs for the first time in nearly three years and the most marked improvement in supplier delivery times since the global financial crisis. May saw the headline IHS Markit/BME Germany Manufacturing PMI – a single-figure snapshot of the performance of the manufacturing economy – register 44.3, down fractionally from 44.4 in April and one of its lowest readings since mid-2012. The fall in the PMI reflected the employment, stocks of purchases and supplier delivery times components.

We'd Really Prefer Not To See This

This is a broad based fall. It's not just the effect on one particular issue. They've falling output - that's the first sign of a recession. They've falling prices - that's called deflation when it's general across the economy. And they've got falling capacity utilization, that's what is lowering delivery times.

Now yes, of course, this is only a couple of months that this has been going on. And yet our task as investors is to try and call the turn in these sorts of things. Sure, this is opinion but it doesn't look to me like this is just a temporary blip. I think we're seeing German manufacturing go into recession here.

But, We know How To Deal With Recessions, No Problem!

Well, yes, we do know how to deal with recessions now. We employ unconventional monetary policy. We print money so that the central bank can go buy bonds both government and private. This lowers long term interest rates, increases the money supply, prevents deflation and brings us up out of the recession.

Except - the European Central Bank is already buying bonds, printing money to do so. Further, they can't really buy many more German ones as there aren't that many around. The German government is running a budget surplus. Also, the ECB must buy bonds in accordance with country weightings. If it buys x more German it must also buy y more Italian, z more French and so on. The ECB is, roughly speaking, at about the limit of even the unconventional monetary policy it can undertake.

This is entirely unlike the UK and US situations.

If Germany does go into recession then there's not a great deal monetary policy is going to do about it. And given current domestic political tensions who holds out much hope for fiscal policy action?

Another area where manufacturers made cutbacks was employment, which fell for the third consecutive month in May. Moreover, having accelerated from the modest rates of decline seen in March and April, the pace of job losses reached the quickest since January 2013.

We're Getting Those Early Warning Signals Of A Recession

These various numbers are the worst they've been since the recession that really got going in 20102 and 2013. Yes, they're only a couple of months old, they're in only one sector of the general economy. And yet manufacturing is the most variable sector of output. And Germany's manufacturing sector is about twice the size, as a portion of the whole economy, as that of near all other rich nations.

It's entirely possible that these are the first signs of that recession.

What Should We As Investors Do?

It's not quite time to run for the doors yet. Certainly not the moment to be dumping everything. But I wouldn't advise new positions in eurozone equities looking at these numbers. And we should be seriously thinking about being defensive. Looking to bonds which will benefit from any further monetary action - what's possible - to alleviate recessionary pressures.

These numbers are only the first glimmer but then that's how turning points are identified, isn't it?

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.