Manufacturing And Services: Coronavirus Punishes The Economy
- The U.S. April 2020 PMI is 41.5 indicating contraction.
- The U.S. April 2020 NMI is 41.8 indicting contraction.
- COVID-19 and the decline in oil prices were severely impacting the U.S. economy.
- The U.S. economy is contracting after over 10-years of expansion.
A greater impact was seen in the indices for manufacturing and services in April. This was due to the combined effect of the coronavirus and oil price wars that have affected the global and U.S. economies. The PMI came in at a reading of 41.5 in April 2020. This was a large drop from March's reading of 49.1. This reading represents the second straight month of contraction for manufacturing. A value over 50 indicates expansion and a value under 50 indicates contraction. Importantly, the U.S. economy as a whole is now contracting after 131 consecutive months of expansion. In 2019, even when manufacturing was contracting, services were expanding. This is no longer the case as services contracted in April 2020, as I discuss below.
Notably after contracting for a good part of 2019, it looked like U.S. manufacturing was recovering in the early part of 2020. But the impact of coronavirus spread across the globe and essentially stopped the global economy for several weeks. The only industries that performed well were Paper Products; and Food, Beverage & Tobacco Products. This is not surprising considering that consumers were hoarding basic necessities and essentials. Notably, I made the call last month that pretty much only Food, Beverage & Tobacco Products would grow. Looking ahead I think that most industries will remain slow. With that said, restrictions are starting to ease in some states. This bodes well for future PMI readings.
U.S. ISM Manufacturing PMI April 2019 - April 2020
Only Inventories Are Increasing
The impact of COVID-19, oil price wars, and transportation restrictions rapidly propagated through the U.S. manufacturing sector and economy in a few short weeks. In April, only 2 out of 18 industries reported growth. This is down significantly from March. Listed in order these are Paper Products; and Food, Beverage & Tobacco Products.
This means that 16 out of 18 industries were contracting in April. Listed in order these are Printing & Related Support Activities; Furniture & Related Products; Transportation Equipment; Textile Mills; Fabricated Metal Products; Nonmetallic Mineral Products; Machinery; Plastics & Rubber Products; Electrical Equipment, Appliances & Components; Petroleum & Coal Products; Wood Products; Miscellaneous Manufacturing; Computer & Electronic Products; Primary Metals; and Chemical Products.
The collapse of oil prices has punished the energy sector as oil rigs were taken out of service and production slowed. The automotive industry stopped production. Companies in these two industries have a large impact on many others. Oil prices continue to stay depressed and automotive production has not yet restarted. It is unlikely that these two sectors will recover to the same activity level at the start of the year in the foreseeable future. This will have a cascade effect on suppliers and service providers to these two large industries.
As one can see from the chart below, all the sub-indices for the PMI are contracting with few exceptions. Supplier deliveries, Inventories, Customer Inventories, and Imports exhibited a positive percentage change. This is likely due to some stocking up and also points to the decline in production and orders. New Orders declined by (15.1), Production dropped by (20.2), and Employment decreased by (16.3). One only has to look at the headlines to realize that almost 30 million Americans became unemployed in a few weeks. The last recession evolved slowly. The speed of this economic slowdown and contraction was dramatic.
ISM April 2020 PMI On Manufacturing
Source: ISM April 2020 Report on Manufacturing
In my article last month, I forecast that April would be worse than March for U.S. manufacturing. This was mostly because I felt that the U.S. trajectory in regard to COVID-19 would be similar to China and other nations. China's economy stopped for essentially two months. In the U.S., we are approaching two months in many states. Now, some states are starting to ease restrictions. This will drive demand and hence there will likely be some bounce back in May of the sub-indices and PMI. However, there is also the risk that infections will rise as restrictions are eased.
Commentary from the ISM report was even more negative than last month and indicates that the coronavirus is causing a significant disruption to U.S. manufacturers. However, the commentary was positive from a company that made N95 masks.
Thirty-percent decrease for April due to COVID-19 impact on both customers and suppliers. (Computer & Electronic Products) - Production stopped, other than to make hand sanitizer for those in need. (Chemical Products) - Our refinery is losing money making gasoline due to the falling demand. (Petroleum & Coal Products) - The company I work for manufactures personal protective equipment [PPE], specifically N95 masks, face shields, as well as selling protective clothing and hand protection. In the area of PPE, our backlog has spiked to numbers we have never seen. While no doubt some of the backorders will be canceled, many of the orders are longer term commitments from [the] U.S. government. (Apparel, Leather & Allied Products) - COVID-19 has destroyed our market and our company. Without a full recovery very soon, and some assistance, I fear for our ability to continue operations. (Nonmetallic Mineral Products)
Services Is Contracting Rapidly Now
Last month I forecast that services would contract. I was largely correct in that regard, although I would rather not be for obvious reasons. The current NMI reading is now at 41.8 in April 2020. This is the first contraction after 122 consecutive months of growth. One can see that all the sub-indices except Supplier Deliveries and Prices are contracting. The increase in Prices suggests that inflation is creeping into the market. This may surprise some since demand is down. It is, however, the result of supply limitations, plant shutdowns, and transportation restrictions. Note that Business Activity dropped (22.0) and is now even lower than Production in manufacturing. New Orders dropped (20.0), which does not bode well for future months. Many retail stores, theaters, sports venues, gyms, etc. remain closed. There are plans to reopen them in the next several weeks. With that said, May will likely still be weak for the NMI reading.
ISM April 2020 NMI on Non-Manufacturing
Source: ISM April 2020 Report on Non-Manufacturing
In April, only two non-manufacturing sectors showed growth. This was a dramatic change from March when almost all non-manufacturing sectors showed growth. Currently, 2 out of 18 non-manufacturing sectors are reporting growth. In order, the 2 expanding industries are Public Administration; Utilities; and Finance & Insurance.
This means that 16 out of 18 non-manufacturing sectors are reporting a decrease. In order, the 16 contracting industries are Arts, Entertainment & Recreation; Agriculture, Forestry, Fishing & Hunting; Retail Trade; Other Services; Wholesale Trade; Construction; Transportation & Warehousing; Mining; Professional, Scientific & Technical Services; Information; Accommodation & Food Services; Management of Companies & Support Services; Educational Services; Real Estate, Rental & Leasing; Utilities; and Health Care & Social Assistance.
Commentary from the ISM non-manufacturing report is much more negative this month due to the large impact of the coronavirus and 'social distancing' requirements. Much of the commentary talks about drop in sales and future re-openings and hopes for a ramp up. The one exception is the Finance & Insurance industry, which seems to be benefitting from the bailouts.
The COVID-19 situation has created significant challenges for the agricultural sectors. Milk prices have declined 29 percent in a few weeks. Milk is being dumped on farms because of the loss of markets. Cattle prices are down 28 percent, pork prices down 24 percent, [and] all agriculture sectors are facing significant price declines. Our agriculture economy is challenged, with poultry, pork, and beef processing plants closed due to COVID-19 cases or impaired due to employees afraid to work side-by-side with other employees. Farmers cannot sell fat cattle locally due to processing plant shutdowns. (Agriculture, Forestry, Fishing & Hunting) - COVID-19 pandemic has forced our business to close as of March 17, 2020. We do not have a re-opening date yet; our purchasing activity has been greatly reduced due to the current business environment. (Arts, Entertainment & Recreation) - Due to increased loans from [the federal] stimulus package, [we are] seeing an increase in new business. (Finance & Insurance) - The oil exploration sector is very weak, with the record low price of oil and the country's shutdown due to the COVID-19 threat. We are hopeful for a bump in activity once the country starts to reopen. (Management of Companies & Support Services)
Final Thoughts on the U.S. Economy and Stock Market
Clearly, the U.S. manufacturing sector, non-manufacturing sector, and U.S. economy have contracted rapidly at a pace not seen before. The Great Recession evolved slowly. On the other hand, COVID-19 impacted the U.S. economy seemingly all at once. Many large companies, small companies, and small businesses in the manufacturing and non-manufacturing sector have shut operations for at least one month or longer. This resulted in an unprecedented loss of over 30 million jobs in a few weeks. It will be a long process to reopen these businesses and gain their customers back. I expect that unemployment will remain elevated for months to come.
On a positive note, the stock market has recovered some of its losses. The S&P 500's price-to-earnings ratio is now approximately 20.6. This is higher than last month's reading of 18.8. Notably, the Shiller price-to-earnings ratio is back up to about 26.7. Neither of these values indicate the market is undervalued. Considering that future expectations for revenue and earnings are low, the market seems to be overly optimistic. I still think that there is a widespread fear of missing out if the market bounces back quickly. Volatility as measured by the CBOE VIX is bounding around 35. This is still high but down from over 75. The long-term average is about 19, so we still have ways to go before we return to 'normal'. The Fear & Greed Index is now only in Fear at a reading of 42. Although it in Extreme Fear anymore, which is a positive sign.
In my opinion small investors should be wary and be selective and judicious in the stocks they buy. I for one, am focusing quality dividend growth stocks. Granted the list of stocks reporting dividend cuts or suspensions due to the coronavirus and oil price wars is growing, and is now over 200. But I intend to stay the course and add small amounts periodically if the market drops again or if I find pockets of value.
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