Services Vs. Manufacturing: Global Purchasing Managers’ Indexes Show the Divide

Lately, we have seen soft landing seemingly become the new watchword amongst financial commentators we follow, who claim there is an increasing likelihood the US Federal Reserve has managed to slow growth and inflation without inducing a recession.^[i] This attitude runs contrary to recent months, where commentators we follow portrayed any signs of economic growth as presaging more rate hikes and a recession. Yet for all the signals that sentiment is starting to warm, we think there are plenty of indications it remains sceptical overall. One such indication: Contractionary Manufacturing purchasing managers’ indexes (PMIs, monthly surveys that track the breadth of economic activity) received lots of attention in publications we follow on Tuesday, which included warnings of an industrial downturn. Yet, in the publications we track, expansionary Services PMIs received scant notice Thursday. Oddly, the reaction is inverse to services’ and manufacturing’s relative economic importance. Strong services have helped the global economy expand during weak manufacturing stretches before, as we will show, and we think they can do so today—something markets likely see even if people don’t.

In the financial news world, we have observed manufacturing typically receives more attention than services, likely because it is tangible, easier to measure and there is far longer data history of doing so. You just count how many widgets rolled off the assembly line. Most services, by contrast, are tough to measure. A dentist might be able to tally the number of teeth filled, but what of the customer service reps—number of calls taken, hours worked, something else? What about the auto mechanics—how do you equalise engine tune-ups, oil changes, tire rotations and brake system flushes? What about housekeeping, investment advice, teaching, interior decorating and writing MarketMinder Europe articles? All are much harder to tally on a pure output basis that captures the extent and complexity of their economic contributions. Add in the nostalgia from when heavy industry was the world’s economic engine, and we think headlines’ focus on factories is quite understandable.

But services, for all the complexity in measuring it, generates the lion’s share of economic activity. In Organisation for Economic Cooperation and Development (OECD) nations (representing developed and late-stage Emerging Markets), manufacturing is just 13% of gross domestic product (GDP) versus a whopping 70.2% for services.^[ii] Whilst it seemingly generates fewer headlines, the latter is much more important to economic growth from a mathematics standpoint.

When manufacturing is weak, economies can still grow if service sectors expand enough to offset heavy industry’s declines. We lived through this in 2015, when much of the developed world’s manufacturing slipped into contraction for a spell.^[iii] Industrial areas had tough times, but strength elsewhere was more than sufficient to pull national economies along, and global output didn’t decline.^[iv] You can see this in US PMIs. (Exhibit 1)

Exhibit 1: Services Trumped Manufacturing in 2015

Source: FactSet, as of 3/8/2023. US Institute for Supply Management (ISM) Manufacturing and Services PMIs, January 2014 – December 2017. Readings over 50 indicate expansion.

In our view, something similar is likely unfolding now. Exhibits 2 – 7 show Manufacturing and Services PMIs since last January in the US, UK, Germany, France, eurozone and China. In the US and UK as you will see, Services are still growing for the most part. The same goes for China, where Services’ ups and downs mostly follow COVID restrictions and flare ups.^[v] In the eurozone and Germany, you will see Services joining Manufacturing in contraction during the stretches that loosely coincided with falling GDP—and Services’ rebounds occurring as GDP recovered.^[vi] France adds a couple recent services dips that coincide with raucous protests in major cities like Paris—which we think makes sense.^[vii]

Exhibit 2: Recent US PMIs

Source: FactSet, as of 3/8/2023. US ISM Manufacturing and Services PMIs, January 2022 – July 2023. Readings over 50 indicate expansion.

Exhibit 3: Recent UK PMIs

Source: FactSet, as of 3/8/2023. UK S&P Global Manufacturing and Services PMIs, January 2022 – July 2023. Readings over 50 indicate expansion.

Exhibit 4: Recent German PMIs

Source: FactSet, as of 3/8/2023. Germany S&P Global Manufacturing and Services PMIs, January 2022 – July 2023. Readings over 50 indicate expansion.

Exhibit 5: Recent French PMIs

Source: FactSet, as of 3/8/2023. France S&P Global Manufacturing and Services PMIs, January 2022 – July 2023. Readings over 50 indicate expansion.

Exhibit 6: Recent Eurozone PMIs

Source: FactSet, as of 3/8/2023. Eurozone S&P Global Manufacturing and Services PMIs, January 2022 – July 2023. Readings over 50 indicate expansion.

Exhibit 7: Recent Chinese PMIs

Source: FactSet, as of 3/8/2023. China Official Manufacturing and Services PMIs, January 2022 – July 2023. Readings over 50 indicate expansion.

We aren’t dismissing the possibility that a recession could still arrive at some point, especially if loan growth in the UK and eurozone stays weak (and US lending follows suit).^[viii] In our view, that isn’t necessarily probable now, but we think it is worth watching, even though persistent recession talk means stocks likely reflected this in last year’s decline, defanging surprise power.^[ix] But as it stands, with PMIs indicating the largest economic sector is still growing in most of the world, we think it is highly unlikely that a downturn is already underway. Better still, with services getting so little attention, continued growth likely remains underappreciated, even amidst all the US soft landing chatter. That suggests to us the gap between reality and expectations remains sizable and stocks’ wall of worry is still pretty high.