It’s time to talk about the elephant in the room. The RSM Manufacturing Outlook Index took a nosedive in March, to levels ordinarily reserved for recessions. The index reversed the gains of the first two months of the year and dropped more than two standard deviations below levels associated with normal manufacturing conditions.
This bolsters our call that the U.S. economy has entered a recession. Investors should anticipate a collapse in the March ISM Manufacturing Index and the sub-index on employment that many use to forecast the monthly employment report to show job losses.
As the figure below shows, reaching below two standard deviations is a rare occurrence. And this period is a most likely candidate for rare occurrences.
The American economy was already coming to the end of the longest modern expansion when it was hit with an unnecessary and misspent corporate tax cut at the end of 2017 that failed to spur investment in the future (and left a budget deficit that could have been used to finance income losses resulting from the coronavirus outbreak).
The tax cuts were followed in 2018 by an ill-advised trade war that sent shock waves through the global economy and body blows to the U.S. manufacturing and agriculture sectors that began to register in October-November 2018.
There has been a slight recovery in the growth rate of manufacturing sales from November 2019 through February 2020, but that was from the low base of a year ago. And now that we are facing a widening health crisis, that upswing is unlikely to last. In fact, that’s what surveys of manufacturers suggest.
Several of the regional Federal Reserve banks conduct monthly surveys of manufacturing activity and sentiment, which we’ve aggregated into the composite RSM Manufacturing Outlook Index. The table below shows that each of the regional surveys has dropped in value since the peaks reached during the 2017-2020 period.
Note: The RSM Manufacturing Outlook Index is measured in Z-scores (standard deviations from normal). The bank surveys are reported as diffusion indices, which vary from bank to bank (but are generally measured as positive responses minus negative responses).
Time series for the individual surveys are included below, with the surveys’ regional diffusion indices shown relative to the growth of national manufacturing sales. Each of the surveys shows a decline in manufacturing from 2017 through the present that coincides with a deceleration in manufacturing sales growth. In most cases (the Richmond Fed survey is the exception, while the Chicago survey is updated through February), the surveys reflect the upticks in manufacturing sales at the end of 2019 and into January and February, which were followed by the sharp drop in the March survey because of the coronavirus outbreak.