Manufacturing on the Mend

Monday’s strong manufacturing report caught our attention, even as the coronavirus outbreak dominated the financial media. At 50.9, the Institute for Supply Management’s (ISM) manufacturing purchasing managers’ index (PMI) for January moved into expansionary territory (above 50) for the first time since July 2019. Trade-related components improved, likely signaling the positive impact of the U.S.-China phase-one trade deal. The forward-looking new-orders component also showed strength.

We must admit that the strong report surprised us given that economic growth expectations, particularly in Asia, have been coming down in response to the coronavirus outbreak. Many Chinese businesses have been closed, travel restrictions have been aggressive, and global supply chains have been disrupted, as we discussed in “Assessing Coronavirus Outbreak.”

We think investors should be paying attention to this positive development, even though one month does not make a trend. “We think this latest evidence of improving manufacturing health bodes well for the outlook for capital spending and corporate profits,” said LPL Financial Chief Investment Strategist John Lynch. “These elements are critical in powering this economic expansion forward, driving accelerating earnings growth in 2020, and supporting stocks at slightly elevated valuations.”

To illustrate what a manufacturing rebound might mean for stocks, we looked back at other periods in which the ISM manufacturing PMI broke above 50. As shown in the LPL Chart of the Day, after these ISM “breakouts,” stocks were higher 6 and 12 months later 90% of the time, with average gains of 5.6% and 14.7%, respectively. Since 1990, the only times stocks fell on this signal were during the 2002 WorldCom and Enron accounting scandals and the bear market following the 2001 recession. Note that this study is based on three-month rolling averages.

Whether this improvement will be sustained remains an open question. A dip back below 50 is certainly possible, particularly when considering the coronavirus impact may be a drag on U.S. manufacturing sentiment in February. Still, this is progress that may bode well for stocks in the months ahead.

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