It is a foregone conclusion that the US economy has entered recession, led by the consumer, which accounts for more than two-thirds of the US economy based on gross domestic product (GDP). The collapse of consumer spending was evident in March personal consumption expenditures data released on Wednesday that showed a record 7.5% month-over-month drop in consumer outlays. It would have been worse if we weren’t stocking our refrigerators and pantries.
The manufacturing sector is also contracting sharply, not surprisingly given the business shutdowns that began in March. Investors had a glimpse of the extent of the hit to manufacturing in the business investment component of first quarter GDP, which revealed a sharp 8.6% annualized decline, durable goods orders for March, which fell 14.4%, and Markit’s preliminary Purchasing Managers’ Index (PMI) for manufacturing in April that came in at 36.9, a level consistent with a severe recession.
Today’s Institute for Supply Management (ISM) PMI for manufacturing—the so-called official PMI—provided more evidence of the depth of the manufacturing downturn. As shown in the LPL Chart of the Day, the headline index fell 7.6 points to 41.5, better than Bloomberg’s consensus forecast of 36, but a level consistent with prior recessions.
But that’s the good news. Peeling back the onion in this report reveals that the headline number was inflated by the supplier deliveries component. Normally, lengthening supplier delivery times reflect strong demand, which prevents suppliers from keeping up. However, in this environment, it reflects supply chain disruptions from lockdowns around the world related to COVID-19.
The new orders and employment components of the report, which both fell more than 15 points to around 27, are better indicators of where manufacturing activity in the US is right now. The new orders number just missed the December 2008 level of 25.9, while the employment component hit its lowest level since 1949, putting the slump into proper perspective.
“The more forward-looking components of the ISM report clearly indicate the manufacturing sector is in the midst of one of the sharpest contractions ever,” said LPL Financial Equity Strategist Jeffrey Buchbinder. “Given the close relationship between manufacturing activity and corporate profits, the 25% cut to S&P 500 earnings estimates for 2020 that we’ve seen since March 1 is probably not enough.”
The ISM report points to a sharp upcoming drop in capital investment and a huge hit to earnings in the second quarter—potentially down 40% year over year (FactSet consensus is calling for a 38% year-over-year decline in S&P 500 earnings).
Looking ahead, while the economic impact of the global lockdowns has been severe, we continue to be reassured by developing plans to reopen the economy, progress toward treatments and vaccines, and the resolve of Americans to get through this. We continue to expect a very strong rebound in manufacturing and the broad economy later this year.
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