September 3, 2019

The Institute for Supply Management’s index of conditions in the manufacturing sector fell 2.1 points in August to 49.1 after having fallen in each of the previous four months.  Clearly, the escalating trade trade war between the U.S. and China is taking its toll on manufacturers.  The PMI has fallen fairly steadily since reaching a peak of 60.8 in August of last year.    The PMI for August at 49.1, if sustained, corresponds to a 1.8% increase in GDP growth.  The earlier numbers were consistent with GDP growth between 4.0-4.5%.  This is clearly indicative of significant softness in the manufacturing sector.  However, a couple of things.  First this index has fallen below 50 on a couple of occasions in recent years — two months in late 2012, and then five months in late 2015-early 2016 — and the economy kept plodding along.  Make no mistake, this softness in the manufacturing sector is a brake on the pace of economic activity, but it is not even remotely close to a level that would point towards an impending recession.  Second, keep in mind that the manufacturing sector is only about 10% of the economy.  Factory employment makes up 8.5% of payroll employment, and in the first quarter made up 11.3% of GDP.  Service sector employment, by contrast, is almost 2/3 of the economy and it is expanding at about a 2.5% pace.

Timothy R. Fiore,  Chair of the ISM’s Manufacturing Business Survey Committee indicated that “Comments from the panel reflect a notable decrease in business confidence. August saw the end of the PMI® expansion that spanned 35 months, with steady expansion softening over the previous four months.  Respondents expressed slightly more concern about U.S.-China trade turbulence, but trade remains the most significant issue, indicated by the strong contraction in new export orders. Respondents continued to note supply chain adjustments as a result of moving manufacturing from China.”

It is important to recognize that the overall index is the compilation of a number of different components — production, orders, employment, supplier deliveries, inventories, prices, the backlog of orders, exports, and imports.

The orders component declined 3.6 points in August to 47.2 after having risen 0.4 point in July..  “Customer demand contracted for the first time since December 2015 (when the New Orders Index registered 49.6 prcent) and ended a 43-month expansion period in which it averaged 58.5 percent.”   An orders index above 52.4  is, over time, consistent with an  increase in the Census Bureau’s series on factory orders.


The weakness in orders overall is, to a large extent, the result of slower growth overseas.  Export orders fell 4.8 points in August to 43.3 after having declined 2.4 points in July and having fallen 0.5 point in June. “The index had its lowest reading since April 2009 (42.9 percent). One of the six big industry sectors expanded, and four contracted during the period. Many respondents continued to note global trade softness as a reason for sluggish activity,”  said Fiore

The production component fell 1.3 points in August to 49.5 after having risen 3.3 points in July.    “Production contracted for the first time since August 2016 (when the index registered 49.6 percent) and ended a 35-month expansion with an average reading of 58.9 percent. Two of the big six industry sectors expanded, and three contracted. Production output was not able to improve customer-inventory positions, and backlog orders contraction rates improved compared to the prior month,” says Fiore.  A level above 51.5 is consistent with an increase in the Federal Reserve’s industrial production figure.

The employment index fell 4.3 points in August to 43.3 after having declined 2.8 points in July to 51.7 after having declined 0.5 point in June..   “Employment contracted for the first time since September 2016, when the index registered 48.9 percent. One of the six big industry sectors expanded, and three contracted during the period. August ended an expansion cycle in which the index averaged 55.8 percent. Comments were generally neutral concerning hiring for attrition. Force reduction comments were minimal, but 25 percent of general comments were negative regarding employment expansion,” says Fiore.  While the economy is currently cranking out about 180 thousand jobs per month, the factory sector thus far accounts for only about 20 thousand of them.  Most of the jobs are coming from services and construction.  An ISM employment index above 50.8 is consistent with an increase in the Bureau of Labor Statistics data on manufacturing employment, so expect manufacturing employment to decline in the august employment report to be released on Friday..

The backlog of orders rose 3.2 points in August to 46.3  after having declined 4.3 points in July. “Backlogs shrank during August due to production output being able to exceed new order intake rates, but the index’s indication of slowing contraction is a positive sign for future production,” says Fiore.

The prices paid component rose 0.9 points in August to 46.0 after having declined 2.8 points in July. “Prices contracted in August, but at lower rates compared to July. Respondents reported decreases in prices for aluminum, corrugate, energy, wood pulp and steel products, but the panel also reported price growth in hot-rolled steel, which is a positive sign for future price recovery,”  A price index level above 52.5 is consistent with an increase in the BLS producer prices index for intermediate materials.

We believe that the economy is  expanding at a relatively robust pace.  We expect GDP growth of 2.5% in 2019 after having risen 2.5% last year.  During that period of time the manufacturing sector will continue to be relatively flat.

Stephen Slifer