Manufacturing sector shrinks for first time in three years

Even though this week will have most Americans distracted from the news while celebrating Independence Day with families and friends, that doesn’t mean that there won’t be important news this week.  On Friday, we’ll get the jobs report from June, which so far doesn’t look promising, as well as a precursor report from ADP on private-sector job growth, as well as other economic indicators for the previous period.  Yesterday, one of the biggest came out — and it was bad news for the US economy.  Manufacturing “plummeted,” Reuters reported, according to the composite index from the Institute of Supply Management:


U.S. manufacturing shrank in June for the first time in nearly three years as new orders plummeted, according to one measure of the sector that provided a stark sign of the economic recovery’s slowdown.

The Institute for Supply Management said on Monday its index of national factory activity fell to 49.7 from 53.5 the month before, missing expectations of 52.0, according to a Reuters poll of economists, and below even the lowest forecast.

It was the first time since July 2009 that the index has fallen below the 50 mark that separates expansion from contraction. That was shortly after the U.S. economy emerged from recession.

The Associated Press analysis says to expect Q2 to come in even weaker than Q1’s stagnation-level 1.9% GDP growth, although perhaps not yet a recession-level number:

Economists said the manufacturing figures were consistent with growth at an annual rate of 1.5 percent or less. That would be down from the January-March quarter’s already tepid annual pace of 1.9 percent.

“Our forecast that the U.S. will grow by around 2 percent this year is now looking a bit optimistic,” said Paul Dales, an economist at Capital Economics. …

Most economists aren’t yet predicting another recession. Though the ISM report suggests manufacturing is contracting, it typically takes a sustained reading below 43 to signal the economy isn’t growing.

Still, U.S. manufacturing, which has helped drive growth since the recession ended, is faltering at a precarious time.


Jim Pethokoukis isn’t as optimistic:

But these numbers are just the latest in a long string of worrisome reports including rising initial unemployment claims, slowing job growth, falling consumer confidence, and declining durable goods orders. Oh, and the rest of the global economy is slowing, too.

The rule-of-thumb recession indicator is back-to-back-quarters of negative GDP growth. But the National Bureau of Economic Research, the group that makes the “official” recession call, uses a broader and more nuanced approach:

It examines and compares the behavior of various measures of broad activity: real GDP measured on the product and income sides, economy-wide employment, and real income. The Committee also may consider indicators that do not cover the entire economy, such as real sales and the Federal Reserve’s index of industrial production (IP). The Committee’s use of these indicators in conjunction with the broad measures recognizes the issue of double-counting of sectors included in both those indicators and the broad measures. Still, a well-defined peak or trough in real sales or IP might help to determine the overall peak or trough dates, particularly if the economy-wide indicators are in conflict or do not have well-defined peaks or troughs.

It takes more than one bad report for a recession, of course, but this isn’t just an outlier of a result either.  Jim uses a 12-year graph of the ISM new orders index, and the trend has been significantly downward since the start of the recovery in mid-2009:


We’ve had a few good months in this series, but a trendline would show a slope downward, and the latest data point drops below anything seen in the early part of the recession in 2007.

What does this mean for the election?  Obviously, a tip-over into recession would be very damaging to Barack Obama’s re-election chances, but it may not take a full-fledged recession for that, either.  Nate Silver analyzed a host of economic indicators in relation to election results over the last 60-plus years, and determined that the ISM index is the most predictive — although still not a slam-dunk sign:

Meanwhile, the best-performing variable has been the ISM manufacturing index, which is a measure of how much manufacturing businesses are ramping up or ramping down their activity. It has had an r-squared of .46.

The manufacturing index has several things going for it. It is considered a fairly good leading indicator of economic activity in general and of jobs growth in particular, and it represents a composite score from five different component indicators, including things like the employment environment and new factory orders.

So does this mean you should all go out and use the ISM manufacturing index in your forecasting models? Actually, maybe not. It is certainly worth looking at. But when you’re testing 43 different economic indicators over a sample of just 16 elections, the best-performing ones are likely to have been a little lucky.


This outperforms changes in non-farm payrolls and changes in the unemployment rate, but only by just a small margin.  Unfortunately for Obama, neither of those are likely to show much improvement in the next four months, either.

Update: The news isn’t all bad, however:

New orders for manufactured goods in May, up following two consecutive monthly decreases, increased $3.3 billion or 0.7 percent to $469.0 billion, the U.S. Census Bureau reported today. This followed a 0.7 percent April decrease. Excluding transportation, new orders increased 0.4 percent. Shipments, up five of the last six months, increased $2.3 billion or 0.5 percent to $476.0 billion. This followed a 0.2 percent April decrease. Unfilled orders, down two consecutive months, decreased $0.4 billion to $984.4 billion. This followed a 0.1 percent April decrease. The unfilled orders-to-shipments ratio was 6.25, down from 6.33 in April. Inventories, also down two consecutive months, decreased $1.4 billion or 0.2 percent to $604.5 billion. The inventories-to-shipments ratio was 1.27, down from 1.28 in April.

Most of the bump came from the transportation sector.  Excluding transportation, orders increased 0.3%.

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