The Institute for Supply Management’s (ISM) Purchasing Managers’ Index1 declined to 49.1 percent in August, the lowest reading in more than three years.2
This index is a key indicator of U.S. economic activity. A reading of more than 50 percent indicates a manufacturing expansion, while anything below 50 percent signals a contraction of U.S. manufacturing activity, which is where we find ourselves today for the first time since 2016.3
Although this news certainly exacerbated investor concerns about a looming recession, it should not have come as a complete surprise. We have seen slowing manufacturing numbers for a couple quarters now, not only in the U.S. but across global economies such as China4 and Germany.5
As the markets continue to digest this news, there are a few key points to keep in mind:
1. Impact of the U.S.- China trade disagreement. The trade dispute between the U.S. and China6 has undeniably played a role in the manufacturing slowdown. We knew there would be costs to engaging in a trade war, and this is one of them. Of course, the hope is that the gains from this confrontation will outweigh any losses and that we will reach a long-term resolution that will be worth the short-term costs. The good news is that the U.S. is in a relatively favorable position to make these demands as the dollar remains strong compared to other emerging and international currencies. In fact, the U.S. Dollar Index7 has risen 10 percent since the trade war began in February 2018.
2. Influx of other economic data. On any given day, there is a flood of information being pumped into the markets that affects pricing. U.S. manufacturing is simply one of many factors that markets are watching. While a manufacturing contraction is certainly significant – as evidenced by the 300-point drop8 in the Dow Jones Industrial Average we saw the morning following the report’s release – it does not necessarily mean markets are going to perform poorly moving forward. Both U.S. markets and global markets have stabilized since the data release.9 As long-term investors, we should not let changing news headlines drive our investment strategy.
3. This is not necessarily a precursor for recession. Often when investors see weakening economic data like the recent yield curve inversion10 or manufacturing contraction, they overreact and think it’s the beginning of the end or that we are heading into a recession. Oil markets had their own overreaction the day following the attack on Saudi oil operations.11 While a recession is certainly a possibility, history suggests it is far from guaranteed. The last time U.S. manufacturing contracted in August 2016,12 markets were negative, but we did not tip into a recession. Today, we again find ourselves in a position where markets aren’t doing too well. The S&P 500 is up only about 4 percent over the last year9 and the MSCI EAFE Index13 is down about 1 percent over the same timeframe. Markets have likely already priced some of this in.
For now, it remains unclear what the recent manufacturing contraction could indicate about the future health of the U.S. economy. That is the nature of investing — making informed decisions during times of uncertainty. In the long run, we should be rewarded for taking on uncertainty and remaining invested in the market.
Sources:
1. Investopedia – ISM Manufacturing Index definition
2. CNN Business – American manufacturing contracted. Here’s what comes next
3. CNBC.com – US manufacturing contracts for the first time in three years
4. South China Morning Post – China’s manufacturing activity remains sluggish in June as higher US tariffs kick in
5. Trading Economics – Germany Manufacturing PMI
6. BBC News – A quick guide to the US-China trade war
7. MarketWatch – U.S. Dollar Index (DXY)
8. Yahoo! Finance – Dow Jones Industrial Average
9. Morningstar
10. Business Insider – The yield curve is inverted. Here’s what that means, and what the implications are for the economy
11. The Economic Times – Saudi oil attack: Where are we a week on and what happens next?
12. ISM.org – August 2016 manufacturing and non-manufacturing ISM Report
13. MSCI¬¬ – MSCI EAFE Index
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