Weakening ISM Manufacturing Report

The ISM Manufacturing PMI was 58.1 which missed estimates for 59.5 and was below the prior report of 60.2. Even though this report missed estimates, it was exactly in line with what I thought would be reported because I looked at the regional Fed reports. They implied a PMI of 58. The chart below shows the regional Fed composite index compared to the ISM PMI. These soft data reports have been stronger than the industrial production report. That being said, I look at all indexes to determine where the economy is headed.

The new orders index fell 3.3 points to 60.2 from 63.5. The production index fell from 62.3 to 58.5. The ISM PMI had been more optimistic than the hard data, so this weakness could mean a slowdown is coming. To be clear, it still shows growth as anything above 43.2% is positive. This PMI is equivalent to 4.6% GDP growth. The weakest reading in the past 12 months was 57.3.

As I discussed after the GDP report came out, the decline in inventory investment hurt GDP growth by 1 point. Firms sold products at a quickened pace to get out in front of the tariffs and then didn’t invest in inventory to replenish what they sold because they are expecting a slowdown caused by the tariffs. The situation is interesting because as you can see in the chart below, the customer inventories index is low as it fell 0.3 to 39.4. However, the inventories index increased 2.5 points to 53.3. There may have been intentional stockpiling to avoid shortages related to tariffs and high steel costs. The chart shows inventories are poised to build. In essence, the situation comes down to tariffs. If there ends up being a trade war, then inventories are too high. If the skirmishes are solved, there isn’t enough inventory.

The biggest reason the index declined is because of the deliveries decline as the index fell from 68.2 to 62.1. Delays in June were the longest in the 70-year history of this report which means it normalized in July. Exports were strong as the index only declined 1 point to 55.3. They were weak in the Markit report I’ll discuss next. The prices index fell, which makes sense because the delivery delays fell, inventories rose, and production fell. The prices index fell 3.6 points to 73.2. That’s still an extremely high reading, so don’t take inflation off your radar screen.

Now let’s look at the quotes from this report to see what firms are saying about business. A computer and electronics products firm stated “Global demand is still strong. Working on contingency plans for the Chinese tariffs. We will probably onshore most of that material. Labor availability is becoming an issue.” Labor availability has been a problem for many firms in manufacturing. The employment index hit 56.5 which was an increase of 0.5. While some firms have had this struggle for quarters, it clearly hasn’t been an across the board issue as this firm is only starting to have this problem.

Tariffs Are Affecting Business

A wood products firm made the following point: “The so-called trade war is now taking its toll on business activity, resulting in substantial reductions to new export orders. China has all but stopped taking orders, causing inventories to build up in the U.S. Domestic business is steady. However, it is too small to carry the load that export markets have retreated from. As a result, we will be meeting as a corporation next week to recast our second-half sales and revenue projections.”

The tariffs are beginning to become an issue even though the stock market has ignored the threat in the past few weeks. The U.S. is now planning to propose a 25% tariff on $200 billion worth of Chinese goods after initially setting the rate at 10%. The chart below shows the size of the tariffs in effect, ready to go, and threatened on both sides. The higher percentage will cause problems. Toyota stated the proposed tariffs would add $3,000 to the sticker price to some of its cars. Specifically, the Camry, which is assembled in Kentucky, would cost $1,800 more; the Tundra pickup truck and the Sienna minivan, which are also assembled in America, would cost $2,800 and $3,000 more respectively. Even though Toyota is a Japanese company, it employs 137,000 Americans.

China Is In Trouble

China is clearly losing the trade war as its manufacturing survey hit an 8-month low in July. The Caixin Markit PMI was 50.8 which is down from 51 in June. The official manufacturing activity PMI was 51.2 in July which is down 0.3 from June. The Shanghai Composite index fell 0.97% on Friday which means it is down 23% from its recent peak and is down 17% year to date. Since the S&P 500 is up 6.24% year to date, that is a 23% outperformance. The Chinese market fell below the size of the Japanese market after surpassing it in November 2014. The Chinese market is worth $6.09 trillion while the Japanese market is worth $6.16 trillion and the U.S. market is worth $31 trillion.

Markit PMI Remains Strong

Just like the ISM report, the July Markit manufacturing PMI was solid but showed deceleration. The PMI was 55.3 which missed estimates by 0.2 and missed last months report by 0.1. Order growth came from the domestic economy as export sales were flat. Production and employment slowed. There are supply shortages and rising prices because of the tariffs. Delivery times were the longest on record and input costs passed through to customers were at a 7 year high. These manufacturing reports make it seem like the sector is on the precipice of weakness if the tariffs continue. In the near term the situation is likely to get worse as more tariffs are being implemented. The main question is when China gives in to America’s demands since its economy is being hit harder by the trade skirmish.