‘Weak’ US Manufacturing Data Aren’t New News

As Americans got down to business after Labor Day, stocks got … down. Headlines didn’t take long to find a supposed culprit for the S&P 500’s -2.1% drop: the Institute for Supply Management’s (ISM’s) August Manufacturing Purchasing Managers’ Index (PMI), which missed expectations and contracted again, hitting 47.2.^[i] Headlines called it evidence investors were too hasty in shrugging off economic risks after freaking over unemployment a month ago. We see an altogether different error: an overestimation of manufacturing’s importance to US growth.

Tuesday’s coverage has one thing right: August’s Manufacturing PMI wasn’t pretty. The headline reading may have ticked up slightly from July’s 46.8, but given readings under 50 indicate contraction versus the prior month, it implies a deeper decline as summer wore on.^[ii] New orders—the most forward-looking component, given today’s orders represent tomorrow’s production—sank from 47.4 to 44.6.^[iii]

Now, this is all a bit squishy because PMIs are surveys. Respondents report their assessment of whether activity rose and fell in a given category, and then ISM mashes that into a reading of the percentage of businesses experiencing higher or lower activity than the prior month. So the PMI tells you how widespread growth (or contraction) was, but not how much activity rose (or fell) from the prior month. Slightly fewer businesses reported an overall decline in August, but significantly more reported declining new business. Other data will show how this translates to growth rates, but for now, not great news.

Crucially, however, manufacturing isn’t the US economy’s lifeblood. We understand why people might think it is. Politicians pander to factory workers, tour plants for photo ops, and laud it all the time. And manufacturing is connected to the stuff we buy. It is tangible and easily counted, and its fruit is everywhere.

But private goods-producing industries—basically, manufacturing—generated just 17.0% of US GDP last year.^[iv] Where did the rest come from? Services, primarily, at 71.7%.^[v] And services mostly operates in its own universe. Manufacturing isn’t a leading indicator for it. They are two separate categories with two sets of sometimes-overlapping drivers.

We already have solid evidence that where manufacturing goes, services and GDP don’t automatically follow. As Exhibit 1 shows, ISM’s manufacturing PMI spent all but one month since October 2022 in contraction, with new orders also mostly in decline the whole way. Output and expenditure-based indicators for heavy industry (chiefly, industrial production and durable goods orders) have also struggled during this span. Yet GDP grew steadily the whole time, defying the steady drumbeat of recession warnings. Manufacturing wasn’t a bellwether. It just was.

Exhibit 1: Manufacturing’s Struggles Aren’t New

Source: FactSet, as of 9/3/2024.

If manufacturing’s long weak patch didn’t derail the US economy or bull market for the past two years, we struggle to see why it would suddenly be a massive warning sign now. It seems more like an extension of the backdrop stocks have dealt with since this bull market began back in October 2022.

Markets move most on surprises, and we daresay factory weakness is neither new nor surprising at this juncture. The 2022 bear market had a host of sentiment-related causes, but recession fear was a big one. That decline likely pre-priced the manufacturing declines that started manifesting late that year to a very great degree. Then, markets spent 2023 learning—if not consciously—that US output can keep growing even if manufacturing gets knocked. Stocks got the lay of the land and moved on. We doubt they suddenly forgot.

This doesn’t mean manufacturing has no sway. Because of its visibility and historical importance, it has a lot of influence over sentiment. Headlines like Tuesday’s affect the general mood. But stocks can fall any old day, for any or no reason. It would be a mistake to conflate what may or may not be a quick sentiment reaction to one bad survey with actual, renewed economic risks. Look past the coincidence to the longer-term trend of stocks rising in the face of rocky manufacturing. Stocks have spent nearly two years telling us factories’ woes aren’t the be all, end all.