Bad Economic Data Strikes Everywhere, As Europe Manufacturing Shows First Contraction In Over Two Years

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Not helping things today: Fresh barometers of the economy in the form of PMI data.

In China. the HSBC's Flash PMI Manufacturing reading came in at 49.4, sub-50 for the thrid straight month, a sign of persistent weakness.

And in Europe, same deal.

According to Markit, the continent is now slipping into contraction for the first time in two years.

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Charting The Incredible Shift From Manufacturing To Services In America

  x You have successfully emailed the post. Doug Short is the vice president of research at Advisor Perspectives.

In honor of Labor Day, which was signed into law as a national holiday in 1894, I spent some time this morning studying a topic I've occasionally mentioned: The shift in the United States from a manufacturing to a services economy.

 The Department of Labor's Bureau of Labor Statistics has monthly data on employment by industry categories reaching back to 1939. The first chart below is an overlay of the compete series of employment numbers for the two major categories, manufacturing and services.

When I say major, I'm referring to the complete domination of the labor market by these two industries. To illustrate this fact, I've also included the total of the two categories and a dotted line showing total nonfarm employment.

In 1939 service industries employed more people than manufacturing by a ratio of 2.1-to-1.0. But that ratio was soon to change. For a clearer picture of the relative growth of manufacturing and services, the next chart illustrates just that: The cumulative growth of the two series, along with total nonfarm employment.

During WWII, manufacturing employment rose dramatically, but it began returning to its pre-war pattern after the war ended. Thereafter, manufacturing employment has had a complex history with a peak in the late 1970s and a secular decline thereafter. Here are some observations about manufacturing and services over the past seven plus decades:

Manufacturing is far more sensitive to the business cycle. Compare, for example, the relative behavior of manufacturing and services relative to the recession bars. Growth in services began accelerating in the 1960s and accelerated again after the double-dip recession in the early 1980. Manufacturing accelerated at a slower pace in the 1960s and then oscillated around a flat line in sync with the four recessions from 1970 to 1982. Manufacturing employment peaked in June 1979. It never recovered from the double dip recession of 1980-1982. The spring of 1998 was the an interim high for manufacturing jobs, but with the recession of 2001 began a 35% decline in jobs from the 1998 peak to the trough (so far) in December 2009. Manufacturing has essentially flatlined over the past 21 months.

Services industry employment began leveling off with the onset of the 2001 recession. Growth began accelerating again in 2004, but the rate of growth was well below what we saw in the 1980s and 1990s. Services employment hit its all-time peak in January 2008, the second month of the Great Recession. Services employment is slowly improving, but it remains about 2.6% below the 2008 peak.

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Be Prepared For A Disastrous ISM Manufacturing Report

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If the “whisper number” for this week’s ISM Manufacturing report is correct then we can expect a disastrous report.  According to LPL Financial the regional manufacturing reports are consistent with a contracting ISM figure:

Based on weakness in various regional ISM and Federal Reserve manufacturing sentiment surveys already released for August (Philly Fed, Empire State manufacturing, Richmond Fed, Dallas Fed), the consensus expects the August reading on the ISM to dip below 50 (to 48.5), from the 50.9 reading in July. The so-called “whisper number” among traders (who often informally have their own forecasts for key economic data and events that differs from the consensus estimate culled from economists) is probably closer to 44.0 or 45.0. Thus, expectations for ISM are quite low. A reading below 50 on the ISM has historically corresponded with contraction in the manufacturing sector, while a reading about 50 suggests an expanding manufacturing sector. The last time the ISM was below 50 was in July 2009, the first month of the current economic recovery.

They warn, however, that it’s unwise to overreact to the negative number.  As they show, it’s not unusual for the ISM to contract during an economic expansion:

As noted in Chart 1, it is not unusual to see the ISM to approach, and dip below, 50 in the midst of an economic expansion. The index dipped below 50 in the middle of the long 1982–1990 expansion and did several round trips above and below 50 in the 1991–2001 recovery, notably in 1995 and again in 1998. In the 2001–2007 expansion, the ISM dipped back toward the 50 level in 2004, before reaccelerating in 2005. More recently, we point out that manufacturing activity/output—vehicle production, industrial production, durable goods shipments and orders, manufacturing employment etc.,have held up much better than measures of manufacturing sentiment like the ISM and the regional Federal Reserve manufacturing indices.

As sustained reading of 42 or below indicates recession, and the ISM did get to that level in both the 1991 and 2001 recessions. It got as low as 33.3 at the worst of the 2007–2009 Great Recession.

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