That 'Manufacturing Recession' in Perspective

If you are feeling a lethargic summer malaise right now, according to recent headlines, it may not be merely the effects of a heatwave gripping much of the world. You may also be in the doldrums because of the global manufacturing “recession”—a two-quarter (and counting) pullback in factory gauges in several major nations. The US, Germany and Italy all fit this technical definition, as do China’s manufacturing Purchasing Managers’ Indexes, which have registered contractionary readings (below 50) for months. Market pundits and presidential candidates alike are seizing on this as very bad news, warning of more trouble in store. We don’t dismiss that times are tough for some companies in some industries, but we think it is a giant leap to say manufacturing’s problems are merely the tip of the iceberg. This bull market has provided contrary evidence, which we suggest investors bear in mind when confronted with fearful headlines.

News cycles have short memories, so we aren’t totally surprised that much commentary on today’s manufacturing recession ignores the simple fact that we also had one in 2015—with no disaster for the economy or stocks. US manufacturing output fell for most of the stretch from November 2014 through April 2016. But there was no actual economic recession. Nor was there a bear market in stocks. There was a correction—sharp, sentiment-driven drop between -10% and -20% or so—but it ran from late-May 2015 through mid-February 2016. Overall, while US manufacturing was receding, the S&P 500 rose 2.9%—not gangbusters, but again, not a bear market.^[i] Lest we forget, there were other sources of uncertainty weighing on sentiment (and stocks) at the time, including the looming US presidential election and Brexit vote.

The fact that we have a prior manufacturing recession during this cycle should throw some cold water on the heated warnings that recently wobbling factory numbers are evidence President Trump’s tariffs are finally starting to bite. Maybe they are! But it didn’t take a rash of new tariffs to launch that last manufacturing recession or its knock-on effect on global trade. That had more to do with oil prices’ swan dive, which wrecked demand for drilling-related equipment. We might be seeing more of the same in non-US oil producing nations this time, too. Canada’s oil industry, for one, is a mess. But more broadly, the main culprits look to us like China’s lingering private sector weakness (an after-effect of last year’s crackdown on non-bank corporate financing) and European auto sector woes. Pundits like pinning auto troubles on tariffs, but that doesn’t pass the smell test. One, auto tariffs are merely a threat now, not reality. Two, while the prospect of tariffs might stir uncertainty, the logical reaction to the uncertainty is to front-run orders before those tariffs take effect, not to wait and see if they happen at all.

Whatever the cause of manufacturing’s doldrums, we don’t buy the argument that they are a leading indicator of broad economic problems. The absence of recession in 2015 isn’t the only reason why. There are also conceptual reasons the fear doesn’t hold up. Developed-world economies are predominantly services-based, with services’ share of GDP ranging from around two-thirds to four-fifths, depending on the country. What is more likely: for a small slice of GDP (manufacturing) to pull everything down, or for mighty services to pull everything up? How would it make sense for a few months’ worth of falling factory output to wreck activity in retail, hospitality, financial services and healthcare? In our view, this all casts even the moniker “manufacturing recession” into doubt. After all, a recession is a lasting, broad-based decline in economic activity. How broad-based a decline can roughly 20% of developed world GDP be?

Perhaps the fear stems from the fact most official leading economic indicator series are heavy on manufacturing inputs, but this stems mostly from antiquated thinking. Economic statistics haven’t kept up with economic development. Perhaps if we had more services-based economic indicators, giving people more information on how the vast majority of the economy is doing, then manufacturing fears wouldn’t be so great. But until the stats catch up—until we have more timely gauges of services-industry output and health—then we are probably doomed to irrational manufacturing fear-mongering now and then.

For investors, the key is to look past all this and remember manufacturing isn’t the economy isn’t the stock market. Moreover, markets look forward, not backward. The past six months’ economic data are immaterial to where stocks go over the next six months and beyond. The gap between reality and expectations will be the driving force. If anything, manufacturing recession fears ought to help widen that gap, setting expectations lower and making the bar easier to clear.