The forward-looking data in the ISM manufacturing report for May was already signaling that the US manufacturing sector was on the brink of lapsing into recession. The Empire State Manufacturing Survey for June, reported today, is one of the first signs that the US manufacturing sector may, indeed, be lapsing into recession.
Manufacturing activity took a sharp turn downward in the New York State region, according to firms responding to the June 2019 Empire State Manufacturing Survey. The headline General Business Conditions index plummeted into contraction territory from a positive +17.8 reading in May to a negative -8.6 in June. The 26.4 point collapse was the largest monthly decline in the history of the Empire State index.
Notably, the new orders index declined dramatically by -21.7 points, from +9.7 in May to -12.0 in June.
Unfilled orders declined from 2.1 in May to -15.8 in June. And unsurprisingly, in these conditions, delivery times also declined.
Survey responses regarding forecasts of conditions six months ahead were significantly lower across the board, including General Business Conditions, New Orders, and Unfilled Orders. Perhaps most ominously of all, the Capital Expenditures Index declined by -15.7 points and the Technology Spending Index declined by -10.0 points.
How To Interpret This Data
There are several important things to keep in mind about the Empire Manufacturing Index:
1. The correlation of the Empire Manufacturing Index to national indices of manufacturing production is quite high. Therefore, investors should take note of this data and what it likely means for other reports on manufacturing to be released in the coming few weeks. It's likely that regional PMIs to be reported for the remainder of May will reflect weakness in US manufacturing activity across the nation. Furthermore, Markit's Flash national PMI later this week and the national PMIs reported in early July (ISM and Markit) will reflect sharp declines in manufacturing activity.
2. The Empire manufacturing index can be quite volatile. Therefore, although May's results are probably an accurate reflection of the general trend in manufacturing activity nationwide, it's also probably the case that the extent of these declines at the national level will not be quite as severe.
3. The Empire State Manufacturing Survey is, as its name implies, a survey. The subjective sentiment of the managers at the time of the survey can influence their responses to questions. I believe that it's probable that the extreme declines in the June survey may reflect temporarily depressed sentiment associated with negative news at the time the survey was compiled regarding the possible imposition of tariffs on Mexico.
What Does This Mean For The US Economy?
It has become "conventional wisdom" that manufacturing is no longer a particularly important part of the US economy. This line of reasoning is often supported by the fact that the manufacturing sector "only" contributes about 11.5% of "value added" in US GDP accounting.
However, as I have explained to my subscribers in Successful Portfolio Strategy, US manufacturing activity is far more important to the US economy than these value-added figures would imply. First, if you add the "upstream" and "downstream" non-manufacturing inputs that are embedded in the final value of US manufactured goods, it turns out that manufacturing activity accounts for about 30% of US GDP. Second, subtracting the impact of government-driven value added (national, state and local), US manufacturing activity accounts for a bit over 40% of all private economic activity. Finally, it's very important to keep in mind that it is a cyclical economic activity which drives the US business cycle. In this regard, my own analysis indicates that US manufacturing accounts for over 50% of the cyclicality of the US economy.
Therefore, a sustained contraction in the manufacturing sector threatens to trigger a US economic recession.
I currently do not believe that manufacturing activity will contract severely on a sustained basis if a trade agreement is worked out between the US and China. However, in the event of a full-fledged US-China "trade war," a US recession is highly likely, led by weakness in the manufacturing sector.
Please note that a US recession is currently not my base-case scenario. My base-case scenario is for some sort of economic détente to be worked out between the US and China. In this scenario, the US economic expansion can potentially motor on for several more years and significant new highs in the US stock market are likely to ensue during the remainder of the cycle.
Exactly how to position one's portfolio in this difficult environment is precisely why you need a good portfolio strategy.
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