Point, meet counterpoint, I suppose.
On Friday evening, Goldman took a quick look at historical instances of ISM manufacturing dipping below 50 and concluded that the recession “hit rate” (if you will) has fallen markedly over the years as manufacturing accounts for a smaller chunk of nominal GDP.
That, in turn, may mean that August’s contractionary ISM print doesn’t presage steep equity losses. “During previous episodes when the US economy did not enter a recession despite ISM readings below 50, the S&P 500 typically rose in the subsequent six months [by] +6% and 12 months [by] +22%”, Goldman wrote.
Well, for what it’s worth, Deutsche Bank offered a more cautious take on things in a note dated Thursday.
“In the US, the decline in equities has not kept pace with falling growth, now at its weakest since early 2016”, the bank’s Binky Chadha said, adding that “the S&P 500 continues to price in a sharp rebound in the ISM (from 49 to 54) which in price terms… leaves the S&P significantly (around 10%) above fair value based on current growth (2600)”.
In the left pane there is a visual that makes a similar point. “In the US, despite recent underperformance by the cyclicals, they are still pricing in a strong rebound in growth and rates”, Deutsche cautions.
Speaking of rates, the decline in 10-year yields looks largely consistent with the burgeoning manufacturing slump stateside.
But there isn’t much that’s consistent about about where credit is trading right now compared to the deterioration in the factory gauge.
“In the US, spreads have been widening since early May as the trade war re-escalated but are still much tighter than levels implied by slowing growth”, Deutsche’s Chadha remarked, in the same note cited above, on the way to noting that “although direct comparisons… are complicated by the large share in credit of the Energy sector then, during the last growth slowdown in 2015-2016, spreads were significantly wider, by almost 100bps in IG and 500bps in HY”.
All of that said, remember that it’s a mistake to conflate manufacturing with the entire US economy. Goldman has been over this before. In July, the bank observed that “manufacturing data such as the ISM and industrial production 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. Recall the following chart:
Still, many veterans will tell you that dismissing manufacturing surveys is a fool’s errand.
Coming full circle, if Goldman’s Friday evening take on ISM and equities was the glass-half-full story, what you just read is the glass-half-empty take. And just to drive the point home, we’ll leave you with one last chart, which, despite (or maybe because of) its simplicity, is poignant indeed.