U.S. Manufacturing and Services Are Recovering
The coronavirus pandemic severely damaged the U.S. economy, but U.S. manufacturing and services are recovering. The sudden shock of U.S. businesses closing for two months or so brought the U.S. economy to its knees. The Gross Domestic Product or GDP declined a whopping 32.9% in Q2 2020 for the prior quarter. This was the largest decline on record. If not for the federal stimulus and liquidity it may have been worse. Government loans kept the doors open for many businesses, small and large, and the loans also kept many people employed. Liquidity from the U.S. Federal Reserve has arguably resulted in surging stock prices and gold prices. Whether the U.S. economic recovery continues without further federal stimulus and liquidity is debatable. But for now, manufacturing and services are recovering.
I have been expecting that the economic recovery will be sharp initially as businesses reopen and pent up demand leads to an uptick in activity. Further, the magnitude of the federal stimulus likely resulted in a surge of consumer spending. Note that the Manufacturing PMI was 41.5 in April, 43.5 in May, 52.6 in June, and 54.2 in July. Note that the Services PMI was 41.8 in April, 45.4 in May, 57.1 in June, and 58.1 in July. So, after bottoming out in April/May the readings soared in June and then leveled off meeting my expectations. The overall economy continues to grow for the second straight month, which is also another good sign for the U.S. recovery. According to ISM, a PMI of 42.8 or better generally indicates an expansion of the overall economy.
However, I expect that demand will subside as federal stimulus dollar values decline. There will likely be a stimulus, but the magnitude is probably going to be less than in the CARES Act, possibly a lot less. Further, unemployment is still high at over 11% and the number of weekly job losses is still high. This will keep a lid on demand and spending. The resurgence of COVID-19 infections in many states is resulting in a pause or even a rollback of business openings and tightening of restrictions. This will also keep a lid on employment growth.
U.S. ISM Manufacturing PMI July 2019 – July 2020
Manufacturing Bounces Off Lows
The impact of COVID-19 and government restrictions rapidly propagated through the U.S. manufacturing sector and economy in March and April. May showed a slight bounce back and business reopening seemingly accelerated from end of May into June. The rate of increase has slowed going into July.
The Manufacturing PMI came in at a reading of 54.2 in July 2020. This was the second consecutive month of expansion after June’s reading of 52.6. A value over 50 indicates manufacturing expansion and a value under 50 indicates manufacturing contraction. That said, there is underlying weakness and employment is still contracting.
More manufacturing sectors are expanding than contracting, same as in last month. This is a good sign for the U.S. economy. It remains to be seen if this will continue with federal stimulus ending or possibly continuing at a lower level. As of right now there is not a consensus on stimulus.
In July, 13 out of 18 industries reported growth. This is the same as in June. Three out of 18 industries were contracting in July. Presumably, the remaining two industries were flat. The top three sectors that are growing are Wood Products, Furniture & Related Products, and Textile Mills. The three contracting sectors are Transportation Equipment, Machinery, and Fabricated Metal Products.
As one can see from the chart below, more sub-indices ticked up than declined. This is a good sign. But there is no large jump as in the prior month indicating the growth is leveling off. New Orders and Production are still expanding robustly, even more than in June. However, Employment is still contracting despite an uptick. Further, Inventories and Customers’ Inventories are also contracting.
The bounce back in June in manufacturing was driven by reopening and pent up demand. It has been sustained into July but seemingly many manufacturers are concerned about the fall. New infections are still rising in much of the U.S. and impacting businesses.
ISM July 2020 PMI On Manufacturing
Commentary from the ISM report were somewhat positive but manufacturers are still saying that COVID-19 is impacting business and orders are slow and demand uncertain. Some of the commentary has indicated that layoffs may occur if business and profitability does not pick up. This does not bode well for future employment numbers. For instance,
Overall business remains down almost 70 percent. We are hanging on to as many employees as possible, but we will have to lay off 30 percent or more for at least two to three months until September or October. (Transportation Equipment) – Incoming orders are slow. This is usually our busiest time of the year, but production is reduced due to lack of demand. Additional layoffs expected. (Furniture & Related Products) – General business conditions are in a general slowing pattern. Many of the plants are on reduced hours and/or furloughs. About 20 percent to 25 percent of plants are scheduled to be consolidated in the next six months to improve margins and profitability. (Nonmetallic Mineral Products)
Services Continue to Grow
The June Services PMI reading continues to show expansion. The PMI reading is now at 58.1 in July 2020, which is a slight improvement compared to the 57.1 reading in June 2020. This is the second consecutive month that services are growing. Notably, employment is still contracting though for the fifth straight month. In a negative note, employment is contracting faster in July than June.
More sub-indices are declining than growing, which is not a good sign for future growth. Business Activity/ Production, New Orders, and Backlog of Orders are still expanding robustly. Several indices are contracting now after surging in June. This includes Supplier Deliveries, Inventories, Prices, and Inventory Sentiment. Employment, New Export Orders, and Imports are all contracting.
Despite the uptick there are still many services businesses that are operating under some kind of government restrictions or on a limited basis. This is especially true for restaurants, hotels and motels, theme parks, sports and entertainment, retail, and colleges. The number of infections still continues to rise in much of the U.S. impacting these businesses severely.
ISM July 2020 PMI on Services
Source: ISM June 2020 Report on Services
In June, 15 of the 18 non-manufacturing sectors showed growth. This is one more than June. The top three sectors are Arts, Entertainment & Recreation, Health Care & Social Assistance, and Retail Trade. The fact that these are the top three are not surprising as they are largely the ones most impacted by government restrictions and ‘social distancing’ requirements in April and May. This means that 3 out of 18 non-manufacturing sectors are reporting a decrease. The three contracting sectors are Other Services, Mining, and Professional, Scientific & Technical Services. The last one is not unexpected as this is probably temp work. Often this is one of the first areas to be cut when companies are looking to trim expenses.
Commentary from the ISM services report is still positive however, COVID-19 is still impacting most services business. Some are even indicating that COVID-19 is changing the way business is done. For instance,
We’re still not certain whether or not the students will be coming back in their full capacity due to COVID-19. This has caused an influx of ordering safety supplies to prepare for the possibility. We have certainly increased our purchasing in the past month or so by a large amount. (Educational Services) – Some business picking up, but mostly virtual meetings, training and consulting. Time will tell if it’s profitable. The economic situation is quite dire regionally, so there is no telling if this is a trend or just a short respite. Any business at this point is much appreciated. (Professional, Scientific & Technical Services) – COVID-19 interruptions are changing the way business is done. (Real Estate, Rental & Leasing)
Final Thoughts on the U.S. Economy and Stock Market
Seemingly, the U.S. economy bottomed out in April. May showed some improvement but still the U.S. economy was contracting. However, the bounce back in June was large in magnitude due to business openings. However, as indicated the GDP numbers Q2 2020 was one of the worst on record. Overall rate of expansion has slowed in July. We are still not back to where we were before the pandemic started. It is likely that the recovery will take until 2021 for that to occur simply because unemployment is still so high.
Payrolls continue to rise but the growth rate has dropped dramatically. The most recent ADP report indicated only +167,000 jobs, much less than expected. Further, small business hiring has slowed. This is despite a large revision for past months. Unemployment is still very high at 11.1%. This is higher than during the Great Recession. Jobless claims are trending down after peak in in late-March, but the number is still 1.186 million, which is much higher than normal. We are still far from normal employment. In addition, the Fed has indicated that the resurgence in new coronavirus infection cases is impacting the recovery and will likely affect the U.S. economy longer than initially expected.
Source: St. Louis Fed
On the other hand, the stock market continues to surge higher drive by mega-cap tech stocks. Apple (NASDAQ:AAPL) is now the most valuable company by market capitalization and is nearing a $2 trillion valuation. The NASDAQ-100 remains in record territory and other indices are rising. The S&P 500’s price-to-earnings ratio is now approximately 28.6, which is higher than last month’s reading. The Shiller price-to-earnings ratio is even higher at about 30.8. These values continue to indicate that the market is overvalued in my opinion. The list of stocks reporting dividend cuts and suspensions is now over 325 and still rising. Investors seeking income and dividend growth should be cautious and seek quality rather than yield in my opinion. Companies with declining earnings and poor cash flows remain at risk for dividend cuts or suspensions.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Source: Seeking Alpha