Non-Recessionary - Weak June Manufacturing PMIs Review

Weak, But Not Disastrous Manufacturing PMIs

With the calls for a recession growing louder despite the stock market at its all-time high and the weakness in the regional Fed manufacturing reports, some investors were prepared for brutal manufacturing PMIs. That didn’t happen, which is a positive. Specifically, the finally Markit manufacturing PMI was 50.6 which is a nice increase from the flash reading of 50.1. If you take the average of 51.1 and 50.1, you get 50.6. That means the 2nd half of June had a PMI 1 point higher than the first half. It might have improved because of the Mexican trade deal earlier in the month. We’ve seen the tariffs impact business sentiment the most out of any other type of economic report.

The June PMI of 50.6 is only one tick above the May PMI. There’s no evidence of a cyclical upturn, but in this situation anything above 50 is a win. It supports the point that very few economic reports show the economy is in a recession even though technically this reading is indicative of a decline in manufacturing. That explains why Q2 GDP growth will be near the economy’s long-run average. If GDP growth was to come in below 1%, it would be a shock and I’d expect positive revisions, just like I expect out of the May employment report.

This was the 2nd lowest manufacturing PMI since September 2009, but hard data reports like industrial production and durable goods orders don’t signal this slowdown is worse than the one from 2015-2016. According to the flash Markit PMI reading, services and manufacturing are in similar shape unlike the 2015-2016 slowdown where manufacturing underperformed. Let’s see if the final services reading shows an improvement too.

June Markit Details

Now let’s review some of the details of this Markit manufacturing report. There was a renewed increase in new business caused by the acquisition of new clients, but its growth was one of the slowest in the past 3 years. The growth in new business internationally was the highest in 2019. That’s at odds with the thesis that the trade war is causing the weakness. To be clear, my thesis is the cyclical downturn isn’t mainly catalyzed by the trade war, but it is a big factor in many business sentiment readings.

Production growth increased from May, but growth still was the 2nd lowest since June 2016 (behind May’s low). The rate of job creation was the lowest since August 2016. 1 year expectations for production growth were the lowest ever. Manufacturing firms mentioned tariffs and weakness in new orders. Input and output inflation were weak. Finally, pre-production inventories fell at the fastest rate since the beginning of 2014.  

In the comment section of this report, the Chief Business Economist of Markit stated “The June survey sub-index readings are consistent with manufacturing output contracting at a quarterly rate of 0.7% and factory payrolls falling by 18,000.” That shows this is a modest downturn; it’s not recessionary, but it’s worrisome. This report was better than the flash reading, but we aren’t out of the woods yet.

ISM PMI Weak, But Beats Estimates

Before the ISM manufacturing PMI report came out, I predicted it would be between 49 and 51.5. It came in at 51.7 which is a relatively solid result compared to where the regional Fed indexes had it coming in at. It beat estimates for 51.1. Make no mistake about it, this wasn’t a good report. It was a weak one that wasn’t as weak as some feared. It fell from 52.1 and was the lowest reading since October 2016. This is much below the 1 year average of 56. This is the 3rd consecutive decline in the index. 12 of 18 manufacturing sectors reported growth. This report is consistent with 2.6% GDP growth. That’s actually higher than most estimates even though this report is weak compared to the recent past. The median of 11 GDP estimates is for 1.8% growth.

(Click on image to enlarge)

The manufacturing sector has been growing for 34 months, but the recent trend is towards slower growth. As you can see from the chart above, the new orders index fell from 52.7 to 50 which is the lowest reading since August 2016. The production index actually increased as it went from 51.3 to 54.1. The employment index also went up as it increased from 53.7 to 54.5. The big weakness was in prices as the index fell 5.3 points to contractionary territory. It’s now at 47.9. This supports the narrative that inflation is falling.

Also, inventories fell 1.8 points to 49.1. Some are using the spread between new orders and inventory to predict the overall index. The current spread signals this slowdown will be the sharpest since 2008. The lag time is 3 to 6 months. Therefore, we will see shortly if it’s accurate. It might not be this time if positive trade negotiations cause a renewed sense of optimism.

ISM Comments

Now let’s look at the comment section. It’s no surprise that tariffs were discussed often. 6 out of 10 quotes mentioned tariffs. A computer and electronic products stated, “China tariffs and pending Mexico tariffs are wreaking havoc with supply chains and costs. The situation is crazy, driving a huge amount of work [and] costs, as well as potential supply disruptions.” This firm will surely become more positive knowing that there is a trade deal with Mexico now. There also might be an improvement in this index because of the renewed talks with China which have put any new tariffs on hold. I will discuss this in more detail in a subsequent article.

Conclusion

The June manufacturing PMIs showed weakness, but they weren’t as bad as some feared. The Mexican trade deal probably adds at least a point to both indexes. The recent ceasefire in additional tariffs between America and China might also improve sentiment. Clearly, the stock market is thinking that will happen because normally such a low ISM PMI would cause selling pressure. Because investors are thinking the latest trade news will help these PMIs, even if they fell below 50, stocks might not have dropped.