S&P Can (And Probably Will) Rally Despite US Manufacturing Contraction, Goldman Says

US equities closed out a second strong week with a third consecutive daily gain, logged Friday amid a soft August payrolls report and a status quo set of remarks from Jerome Powell in Zurich.

The Fed Chair’s comments were essentially a rehashing of familiar talking points. He’ll “act accordingly” in the face of rampant uncertainty to sustain the expansion.

For the week, the S&P rose 1.8%, no small feat considering how rocky things were on Tuesday when, fresh off the three-day weekend in the US, Donald Trump unleashed a series of abrasive tweets aimed at Beijing, among other foes.

It’s also notable that stocks held up despite the first contractionary ISM manufacturing print in three years, which came hot on the heels of the worst consumer sentiment reading of the Trump presidency.

When taken in conjunction with the August payrolls miss and the accompanying revisions, the picture isn’t all that bright for the White House.

But a contraction-territory ISM isn’t necessarily a death knell. In fact, Goldman suggests it might be a blessing in disguise.

“In six of 11 instances since 1975 a recession did not occur despite the fact the ISM fell below 50”, the bank wrote Friday evening, adding that “during these six episodes, the ISM index typically declined for six months from 50 to its trough [and] did not decline below 45.5 in any of the six episodes whereas in recessions the ISM usually fell below 40”.


The silver lining, for those predisposed to glass-half-full takes, is that “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 notes.


In essence, this is just another play on the thesis that says manufacturing recessions aren’t as concerning for the US economy as they used to be.

The bank’s David Kostin underscores that.

“The ISM was a much better predictor of US recessions during the 1970s and 1980s (75% hit rate) because manufacturing accounted for 20% of nominal GDP and 60% of GDP growth volatility”, he remarks. Over the past couple of decades, though, the recession hit rate from sub-50 ISM manufacturing prints is just 30%, which Goldman suggests is attributable to manufacturing now accounting for just 10% of nominal GDP.

The bottom line is that, as Kostin puts it, “a modestly contracting manufacturing economy may not drive an overall recession”, and therefore may not lead to outsized losses in equities.

Fingers crossed.


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7 thoughts on “S&P Can (And Probably Will) Rally Despite US Manufacturing Contraction, Goldman Says

  1. I’ll be skeptical of the Wall Street Strategists’ “risk on” calls until I start to see better relative strength in the small caps, mid caps, transports, energy, and regional banks. The last few moves higher to ATH’s have felt very “narrowly defined”, in my opinion. Feels more like a “kinda/sorta risk on” mood right now.

  2. H-Man, you have to wonder what $17 trillion of negative debt will be valued at if rates rise and the corresponding impact on equities. A few months ago, it was $14 trillion. A few months from now maybe $20 trillion. So how much is enough before the market breaks? Central banks will have to pay the piper and the price will be steep. Talk about a bubble. More like Mount Vesuvius than the Ice Age.

  3. The point that manufacturing is a declining part of US GDP and employment, so that manufacturing slowdowns are less reliable leading indicators of recession, is much-made nowadays.

    Some counterpoints to consider:
    – Manufacturing and related represents a larger portion of SP500 revenue than it does of GDP.
    – GDP includes final goods and fails to capture all the intermediate manufacturing and shipping steps which, while invisible to GDP, do represent economic activity.
    – With GDP growth so weak already (2%), the economy may be less resilient to a slowdown in the manufacturing-related part.

    My take is that slumping ISM, PMI, freight, capex, etc don’t themselves constitute
    a recession or make one inevitable. But they do increase the probability of a recession.

    Incrementally higher recession probability -> incremental change in portfolio exposures.

    1. “GDP includes final goods and fails to capture all the intermediate manufacturing and shipping steps which, while invisible to GDP, do represent economic activity.”

      I haven’t thought of this but it seems an excellent point and one of the problems with GDP. Value chain components create both critical costs to manage and critical sources of gain for those who supply them to others. Once again this point exposes the age-old source of economic tension, you can’t have everyone happy at once. Amazon cuts its shipping cost and FedEx suffers. Import from China and consumers are happy but the President and his “base” are not. Can’t really think why but as H might say, there it is.

  4. I agree. It has been apparent for sometime that equities want to rally, so who am i to argue against it.
    The problem is that algos don’t distinguish between headlines, ie they equally weigh headlines from trump and macro headlines as being the same, the market sells off, and then recovers immediately, when clearly the headlines between macro and news events are not the same one is very much significant and should weigh on expectations, and one is on a limited time frame, a day a week, a month etc. We have to make money it doesn’t matter how stupid the whole thing has become. As i see it one has two choices, either use this rally to accumulate shorts and hedge as long as it lasts, looking to make money on a longer time frame, or ride it and buy into it. Another interesting fact is that not only do algos not distinguish between the significance of headlines but they don’t distinguish between different asset classes and see them as one giant correlated asset the “Risk on” asset class. For instance this week equities rallied, and so did copper, gold was sold, so did treasuries and corporate debt. The algos treat all these different asset classes the same, of all the asset classes in the world copper should be the last one to rally specifically because even if everything is fine, the contraction of manufacturing around the world should be enough to merit a continuation in selling, but this is not the case with algos. When risk is on, buying WTI means you are buying stocks, and selling gold means long equities and short treasuries, so for anyone that tries to diversify this point should be important. The biggest correlation however is corporate debt and sovereign debt to be sure this correlation has always existed, but today in a negative yielding world this correlation means a complete different thing. It suggests that corporations are countries, so look for the next crisis, the biggest shock will probably be the uncorrelation of corporate deb and sovereign, that probably will precede a sovereign debt crisis. Stay beautiful, if you are short grow a pair you will need them until the crisis starts or at least until trumpolini tweets something.

  5. Goldman whistling past the graveyard here. Try running their analysis with “US contractionary print at the same time that 10+ G20 economies also have Mfg PMI < 50” and see what happens then. We’re presently at 13 G20 countries under 50, I believe. Mfg may be relatively small here, but our equity markets do not run context-free.

NEWSROOM crewneck & prints