Monday, March 7, 2016

Officially (by me) a Manufacturing Recession

The term “manufacturing recession” started appearing more frequently in economic articles and discussions beginning last October.  It is an odd expression from an economist’s standpoint.  If the entire economy were in recession, then it would just be a recession.  Consequently, for just a manufacturing recession to exist, the non-manufacturing segment of the economy would have to be growing enough to offset the manufacturing slump and result in a positive GDP number.

This is entirely possible because manufacturing now makes up only around 12% of economic output, while consumer goods and services are 70%.  However, manufacturing recessions are still rare since most of the time the manufacturing and the consumer sector of the economy move somewhat in sync. You would also not expect a manufacturing recession to last an extended time period.  Either the consumer sector would weaken, resulting in a standard recession, or manufacturing would recover and “rejoin” with the rest of the economy.

In addition, manufacturing recessions would tend to be mild.  Any significant downturn in manufacturing would probably lead the economy into a recession and, while the consumer sector and manufacturing can move in opposite directions, the gap between them will not be wide for very long.  Therefore, “manufacturing recessions” should be short and mild.

The term caused a vigorous debate in our recent FTR internal economics meeting.  Somebody asked if the economy was in a manufacturing recession, and we had problems answering that question.  It was pointed out that a manufacturing recession is more severe than a slowing in manufacturing growth.  We all agreed the manufacturing sector had been slowing for several months.  We also agreed that we would not use the term “manufacturing recession” because we could not define the term.

That worked fine for a few minutes, until someone used the term again and the debate started all over again.  I then offered a definition for “manufacturing recession” which I will share with everyone here.

Manufacturing Recession Defined

A manufacturing recession occurs when the PMI Manufacturing Index (Institute for Supply Management) is below 50 for six consecutive months, and during a time that GDP is not negative for two consecutive quarters (the standard definition for an economic recession).

The manufacturing PMI is one of the most accepted measurements of manufacturing activity.  Readings above 50 indicate expansion and those below, contraction.  The index is reported monthly and thus very easy to track.  The reason for the six-month time period is that it corresponds to two quarters of GDP, the recession yardstick.

Where Are We?

Here are the PMI readings for the last six months: 

September = 50.0 (equal to no growth)
October =     49.4
November = 48.4
December = 48.0
January =      48.2
February =    49.5

Therefore, by my strict definition, a manufacturing recession will be declared if the manufacturing PMI is below 50 in March.  But because there has been no manufacturing growth since August, I am going to invoke the “horseshoes and hand grenade rule” and say, yes, we are in a manufacturing recession. And
kudos to the people proclaiming in October and November 2015 that a manufacturing recession had begun; they turned out to be correct!

What about GDP?

For a manufacturing recession to occur, GDP cannot be negative for two consecutive quarters.  This would happen when non-manufacturing is growing and manufacturing is moderately declining, and we would expect GDP to be positive, but weak.  The current 2015Q4 estimate of 1.0% clearly fits the criteria.  The WSJ Economic Panel is forecasting 2.0% for Q2.  Based on the current manufacturing data, the Q2 estimate would appear to be a bit too high.

However, based on this Q2 GDP forecast, the PMI rising two straight months, and the February number at 49.5, it appears that manufacturing will begin growing again in March, and the “manufacturing recession” will end.  The FTR freight forecasts do not show manufacturing getting much better for the rest of 2016, however.  Truck freight growth is forecast to grow an anemic 1.3% this year.  

If manufacturing is able to contribute, even moderately, to GDP, it would indicate that we can make it through 2016 without a recession.  However, the economy will not have much momentum entering 2017, as this long, slow, extended recovery will eventually have to run out of steam.  

 This post first appeared on the FTR website.  FTR is the leader in analyzing and forecasting the commercial transportation industry.  For more information on FTR reports and services, please click here.)

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