Don’t Confuse Manufacturing With The Broad Macro Trend

Last week’s news that the ISM Manufacturing Index dipped below the neutral 50.0 mark in November for the first time in three years has inspired some folks to declare that the US economy is on the verge of slipping into a new recession. Perhaps, but letting one indicator drive your analysis of the business cycle is a dangerous game that’s prone to a high degree of error. On the other hand, seeing a new contraction on a semi-regular basis makes for exciting TV interviews.

A sober reading of history, by contrast, is dull (and enlightening). Consider the facts. The ISM Manufacturing Index has fallen below the neutral 50.0 mark 38 times since 1948. (Note: any dip below 50.0 is considered separate and distinct by way of at least one subsequent rise to 50.0 or higher.) Over the same period, the US economy has tumbled into recession 11 times, according to NBER data. In other words, using the ISM Manufacturing Index in isolation to gauge recession risk has a dismal record as a tool for deciding if the economy is in an NBER-defined downturn.

That doesn’t mean that it the ISM is worthless—far from it. But like every other indicator, context is critical. Using one indicator (or even two or three) for business-cycle analysis is like driving with one eye closed. You may get to your destination without incident, but you’re needlessly exposing yourself to a high degree of danger on the journey.

The good news is that wider context (a safer journey) is easily available. In addition to the proprietary numbers published on The Capital Spectator, there are several robust business cycle indexes at your disposal—the Chicago Fed National Activity Index and the Philly Fed’s ADS Index, for instance. And just to be clear, recession risk is low according to the latest numbers for all of these metrics.

But if the manufacturing sector is in recession, as it appears to be via the ISM data, doesn’t that confirm that the US must be contracting as well? No, not even close, as a review of the ISM and NBER data reminds. Even if you assume that manufacturing’s influence over the broad macro trend is much higher than the empirical record suggests, there’s still room for doubt about the state of growth in the here and now.

Markit’s Manufacturing PMI, another survey-based data set, tells us that the sector is still expanding as of November. Granted, the PMI dipped to 52.8 from 54.1 in October, confirming what’s been clear for some time—manufacturing activity is weak. But using the latest PMI numbers as a guide points to US annualized growth in the fourth quarter of around 2%, according to Markit’s chief economist, Chris Williamson.

But rushing to judgment has a long history in the dark art of analyzing the business cycle—“The Endless Parade of Recession Calls,” as Bill McBride at Calculated Risk labels the habit. Eventually the pessimists will be right a la the broken-clock phenomenon. But seeing a recession behind every weak number is akin to practicing a type of religion.

Fortunately, there are more reliable ways to monitor macro risk. But there’s a catch, and one that won’t win you any plaudits on TV: You’ll have to be willing to look at more than one factor at a time.