The RSM US Manufacturing Outlook Index continues to anticipate a slowdown in production, remaining negative in October at -0.59 standard deviations below normal conditions for the manufacturing sector. This is a slight improvement from its September value of -0.79 standard deviations.
The MOI is a composite index based on surveys of manufacturing sentiment conducted by six regional Federal Reserve banks and can therefore be considered representative of the direction of national manufacturing activity.
What began as a slowdown for manufacturing in the summer of 2018 is now approaching levels that suggest a recession in the sector.
October also marks the seventh month in a row of a decline in manufacturing activity as reported by the regional bank surveys. The October MOI shows the tenth month with negative values out of the last 12 months, reinforcing the view that the economy reached a pivot point in the third quarter of 2018 as the U.S. trade war took effect.
Actual manufacturing sales data compiled by the U.S. Census Bureau indicate that the yearly growth rate of manufacturing sales has been less than 2% since May and slipped to an anemic 1.1% annual rate in August, the latest available data.
Of note, the median forecast for the October ISM Purchasing Managers Index of manufacturing activity is below 50 for the first time since the 2015-2016 mini-recession brought on by the collapse of commodity and oil prices. The ISM is reported on the first day of each month, with values above 50 indicating growth of manufacturing and values below 50 indicating a decline.
Beneath the Z-score
The RSM Manufacturing Outlook Index 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, while Z-scores greater than 2.0 or less than negative 2.0 suggest conditions that are significantly above or below normal levels of sentiment and are 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, which is in line with the global manufacturing slowdown.
Cross-country outlook for manufacturing
The RSM Manufacturing Outlook Index is a composite of surveys of manufacturers’ sentiment in the districts of the six regional Federal Reserve banks. Because of geographic differences and the dominance of local industry, you would expect there to be variance in sentiment levels. For example, business sentiment in Texas and western New York is probably more dependent on the energy prices than other regions, while sentiment in the Kansas City district is more dependent on the outlook for commodity markets. As would be expected, the inclusion of additional regions into our MOI increases its correlation with national manufacturing sales and overall economic growth.
A couple points to note: (1) the outlook for manufacturing in each of the six sectors is substantially lower than the post-crisis peaks in sentiment; and (2) the outlook for manufacturing in each of the regions has been declining on trend since the summer of 2018.
Click here for charts of manufacturing sentiment in each of the districts and the growth of national manufacturing sales.
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 Friday, Nov. 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.
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.