The RSM US Manufacturing Outlook Index continues to anticipate a decline in manufacturing, falling in September to -0.84 standard deviations below normal conditions for the manufacturing sector from -0.55 standard deviations in August (see Figure 1).
It’s the latest piece of data pointing to a slowdown in the economy, one that has been accelerating worldwide and creating headwinds for middle-market businesses in the United States.
The index is a composite based on surveys of manufacturing sentiment conducted by six regional Federal Reserve banks and can be considered representative of the direction of national manufacturing activity.
After what looks to have been a summer bump for manufacturers, preliminary indications — with four of six regional banks reporting — suggest that manufacturing conditions declined again in September. That would mark the sixth consecutive month of negative values for the MOI. (The index has been negative in nine of the 11 months since November 2018, the presumed turning point for the business cycle.)
The actual level of manufacturing sales has in fact declined on a monthly basis for five of the nine months since November 2018, with the latest data showing the yearly growth rate reaching below 1.3% in July.
The MOI is reported as a Z-score, the number of standard deviations that manufacturing sentiment is above or below normal conditions. A value of zero indicates normal levels of sentiment, with Z-scores greater than 2.0 or less than negative 2.0 indicating conditions that are significantly above or below normal levels of sentiment indicative of bubbles or extreme distress in the manufacturing sector.
For example, the MOI has been significantly below normal levels of sentiment in the periods before recent recessions in 2001 and 2007-2009, and during the commodity price crash of 2014-2015. In the current cycle, the index turned negative in December 2018, a reason to think the economy is nearing the end of the decade-long recovery from the Great Recession and has perhaps moved past this business cycle’s pivot point.
Cross-country manufacturing outlook
Because of geographic differences and the dominance of local industry, variance in sentiment levels in the RSM Manufacturing Outlook Index can be expected. For example, business sentiment in Texas and western New York is probably more dependent on energy prices than other regions, while sentiment in the Kansas City district is more dependent on commodity markets. But overall, the inclusion of additional regions into our index increases its correlation with national manufacturing sales and overall economic growth.
A couple points to note: the outlook for manufacturing in each of the six sectors is substantially lower than the post-crisis peaks in sentiment; and the outlook for manufacturing in each of the regions has been declining on trend since the summer of 2018.
The ISM benchmark for manufacturing conditions
The Institute for Supply Management’s purchasing managers index, or PMI, is the benchmark business conditions index for the financial markets. It often leads changes in the direction of the business cycle, as illustrated in Figure 2. The next release of the ISM index will be Tuesday, Oct. 1.
Knowing the pivot points of the economy should lend insight to the direction of monetary and fiscal policy and the potential returns on asset prices. The monthly ISM PMI should be an essential guide for middle-market decision-makers, helping to gauge future supply and demand requirements.
In ISM’s August 2019 Report on Business, the headline was clear, saying, “New Orders, Production and Employment Contracting.” The article went on to note “the end of the PMI expansion that spanned 35 months” and a “notable decrease in business confidence”.
The ISM index is based on a monthly national survey, with the ISM diffusion index reported on the first business day of the following month. Respondents are asked to evaluate business conditions, answering if conditions in the current period are better, worse, or about the same than in the prior month. The percentages for those three choices are determined, and the diffusion index is calculated such that that a value of 50 represents no change from the prior month, with the distance above or below 50 representative of the direction and rate of change.
