Bucking the slump of August, American manufacturing activity grew in September with PMI rising to 51.5% (a reading of 50 or higher points to growth), up 2.1 percentage points from the August reading of 49.4% and above economists’ expectation of 50.6%. 

New orders and production registered a jump in the month though exports were still a drag. Employment in the manufacturing sector grew 1.4 percentage points. With this, the 12-month average manufacturing PMI came in at 50.3, with a high of 53.2 hit in June and a low of 48 touched in December.

Investors should note that huge capex cuts by energy companies to fight back the plunge in oil prices and sluggish export demand in the wake of global growth issues were the glitches in the manufacturing sector. If oil prices are able to sustain an uptrend thanks to a likely output cut deal in November, such threats may diminish in the coming days.

Of the 18 manufacturing industries, seven recorded an increase in September with nonmetallic mineral products, furniture, textile mills, food, beverage & tobacco products, paper products and computer & electronic products deserving special mention.

Plus, the U.S. economy has been expanding at its quickest clip in two years, helped by solid consumer spending and decent business investment. After the final upward revision, GDP growth data for Q2 came in at 1.4%, following a 0.8% tick-up in Q1.

Market Impact

The dual doses of upbeat manufacturing and GDP data triggered another round of rate hike bet. Chances of a rate hike by December surged to 60%, as per futures data compiled by Bloomberg.If this was not enough, Cleveland Fed President Loretta Mester, indicated on Monday that there might be "live" discussion in favor of a rate hike in November meeting.

As a result, Treasuries slumped, with two-year note yields surging to almost a three-week high. The yield on two-year Treasury notes rose 3 bps to 0.80% on October 3, 2016, from the previous day while the yield on 10-year U.S. Treasury note too increased 3 bps to 1.63% following the release of manufacturing report on October 3, 2016. On the other hand, broader U.S. equity gauges slipped on rate hike fears.

ETF Picks

iPath US Treasury Flattener ETN (FLAT - ETF report)

To play the flattening of the yield curve which is happening at this moment, FLAT which provides inverse exposure to the Barclays US Treasury 2Y/10Y Yield Curve Index, can be a good bet. FLAT advanced over 1.9% on October 3, 2016.

Industrial Select Sector SPDR ETF (XLI - ETF report)

With industrial activity gaining pace, a look at this industrial ETF makes sense. XLI added about 0.1% on October 3, 2016.

PowerShares DB US Dollar Bullish ETF (UUP - ETF report)

If rate hike talks continue for the next few days, the greenback is sure to bounce, especially after a subdued year-to-date performance. So, investors can tap UUP to make some gains as long as rate hike speculation remains rife. UUP added about 0.2% on October 3, 2016.

Stock Picks

We pick stocks from industries that saw manufacturing growth in September. The stocks have a Zacks Rank #2 (Buy) and are thus expected to outperform their peers in the months ahead.

Pinnacle Foods Inc. (PF - Analyst Report)

Pinnacle Foods manufactures a wide range of packaged foods under several brand names. Its products include Duncan Hines cake mix, Mrs. Butterworth's syrup, and Vlasic pickles. The expected year-over-year earnings growth rate for this fiscal is 11.3%.

Identiv Inc. (INVE - Snapshot Report)

It is a global security technology company that belongs to the computer and peripheral equipment industry. Its products are used in employee identification cards, company email, information technology networks and so on. The expected earnings growth rate for this fiscal is 48.9%.

Domtar Corporation (UFS  - Analyst Report)

Domtar is a manufacturer of pulp and forest products and fine papers. Though its earnings are expected to decline 9.9% in fiscal 2016, the stock has a solid VGM score ‘A.’ UFS added about 0.7%.