Although the administration hasn’t always agreed with Goldman’s analysis on how the president’s policies will affect the economy (with Kevin Hassett’s infamous “opposition research” quip being the most famous example), Trump would likely agree with the bank that “manufacturing has become a smaller and less correlated part of the economy”.
That’s quote from a Friday note that finds Goldman warning against placing too much emphasis on manufacturing data given its dwindling impact on swings in overall economic output and labor market indicators.
The bank’s analysis is short and to the point. Frankly, this particular note is as illuminating as it is timely and serves as a testament to the idea that there’s beauty in simplicity and merit in illustrating the intuitive. That is, there’s nothing particularly novel about it, but it’s germane in the current environment.
Goldman starts by noting that “manufacturing data such as the ISM and industrial production reports account for 25% to 45% of the bond market impact of activity data surprises”, figures that are grossly disproportionate to manufacturing’s share of the real economy. Have a look at this chart:
Goldman does note that this isn’t quite as out of whack as it seems. “Directionally, Wall Street’s focus on manufacturing makes sense”, the bank says, adding that “manufacturing activity is more volatile than the rest of the economy [and] the sector still accounts for 37% of the S&P 500 market cap”.
That said, the important point is that the manufacturing sector simply doesn’t play a large role in explaining the variability in GDP and non-farm payrolls. Indeed, as Goldman writes, “the contribution from manufacturing to GDP volatility has fallen from 60% in the early 70s to 20% now”.
What accounts for that? Well, a trio of factors. For one thing, manufacturing output as a share of GDP has fallen off a cliff over the past seven decades. Additionally, better inventory management techniques have reduced volatility in the sector while the non-manufacturing economy isn’t as correlated with factory activity as it was in the past.
The takeaway is obviously that while recent weakness in manufacturing stateside is concerning (especially as it suggests the deepening global factory slump is finally coming home), it’s important to keep things in context. The read-through for the economy is straightforward. “We are not too worried about the Q2 slowing of manufacturing data”, Goldman says.
This is ironic from the perspective of the White House. While it’s good news that recent weakness in factory activity isn’t likely to deep-six the expansion, if you’re the president, it’s a cryin’ shame that the US economy doesn’t live and die by the vagaries of the manufacturing sector.