What do you do when two indicators seemingly measuring the same thing point in different directions? Those closely watching UK manufacturing lately may have encountered this very conundrum, with purchasing managers’ indexes (PMIs) diverging from the ONS’s official industrial production measure. Whilst the former suggests contracting activity, the latter—though not strong—has trundled along. The apparent conflict can be confusing, but understanding how each works could help clarify the situation, allowing investors to better see the underlying reality and how well expectations match it.

From last August through its latest July reading, S&P Global’s manufacturing PMI has been below 50, the dividing line between expansion and contraction.^[i] In other words, over the last 12 months, less than half of firms the S&P Global surveys have reported growth in their business. Whilst a timely read—PMIs are generally the month’s first economic report—they don’t tell you how much businesses grew or contracted in aggregate, only whether a majority saw output grow or contract.^[ii] So even if a majority of firms reported declining activity, if the minority grew more than the rest shrank, actual output may still be net positive. This appears to have occurred as summer kicked off.

Looking at just the manufacturing component of industrial production (stripping out mining & quarrying, oil & gas extraction and utilities), Exhibit 1 shows output grew in June (the latest reading) and is up since August 2022—when the PMI first fell sub-50.

Exhibit 1: Manufacturing PMI vs. Output Levels

Source: FactSet, as of 22/8/2023.

Many commentators we follow portray manufacturing PMI weakness as a sign of recession (prolonged economic contraction). But we find a glaring problem with this: Manufacturing is only 9% of gross domestic product (GDP, government’s measure of economic output).^[iii] The services sector is a far larger 79%—and its PMI has topped 50 since February.^[iv] But as manufacturing production data in Exhibit 1 also show, actual output has been more resilient than manufacturing PMIs suggest. It appears to us production volumes are clawing their way back even if the majority of firms’ business shrank.

Mid-month industrial production reports lag early-month PMIs by a couple weeks.^[v] This is because PMI surveys are conducted over several days during the month—facilitating their early release.^[vi] Tabulating output data requires waiting until month end. Whilst it is easier to ask firms how business is going (so-called soft data) than to count up everything they made during the month (hard data), we have found the latter’s detail offers vital clues on the former’s initial read. We think current manufacturing output trends show recovery—and don’t confirm PMIs’ headline message of worsening contraction.

The lesson for investors, in our view: Pay attention to PMIs’ early reads on the breadth of growth, but keep in mind these data are provisional—and fuzzy, especially near 50, when roughly equal amounts of surveyed firms are split on their assessment. Since PMIs don’t account for the size of their production, only output data can reveal growth’s magnitude. Although that can be volatile month to month, in our experience, checking PMIs against output trends gives a better sense of what is actually going on under the economy’s bonnet—and whether narratives and sentiment covering it are accurate or not.