Global Macro Strategy

A weekly analysis of timely economic strategy issues from Wells Fargo Investment Institute.

January 10, 2017

Craig P. Holke, Global Research Analyst
Paul Christopher, CFA, Head Global Market Strategist

Continued Signs of Recovery in U.S. Manufacturing

  • Manufacturing recently has faced many difficulties, from slowing domestic and global demand to an appreciating U.S. dollar (making American goods less affordable overseas). This has led to a decline in business investment that has had a negative effect on economic growth.
  • There are signs of moderate, but sustainable, recovery in the manufacturing sector. Surveys on new orders, employment, and management’s willingness to invest all have reflected improvement in recent months.

What it may mean for investors

  • An improvement in the manufacturing sector likely will lead to increased business investment and broader economic growth, and help to support a recovery in corporate earnings.

Several factors contributed to the difficulties faced by the domestic manufacturing sector following the most recent recession. Domestic and global demand declined significantly due to the global financial crisis. This reduction in demand led to a decline in production orders and, as a result, a decline in output and employment. As Chart 1 shows, manufacturing sector sentiment contracted sharply in 2015. It stabilized at the start of 2016 and has been recovering since that time. Sentiment regarding employment in the manufacturing sector continued to weaken for most of 2016. The economic resurgence (that began before the U.S. elections) ticked higher as firms expected stronger orders in the fourth quarter, in turn, benefiting manufacturing.

Chart 1. Sentiment Among Domestic Manufacturers Continues to RecoverChart 1. Sentiment Among Domestic Manufacturers Continues to RecoverSources: Institute for Supply Management (ISM), Wells Fargo Investment Institute, 1/6/17. Note: Each month, the ISM asks purchasing managers if sentiment is better, worse, or the same. The results are calculated so that 50 denotes “the same,” and values above (below) 50 denote better (worse). We show three-month moving averages to reflect trends more clearly.

Domestic Manufacturing Continues to Show Signs of Recovery

In general, businesses have held off on investing in their operations due to increased uncertainty over demand—with manufacturing having been hit harder than the rest of the economy by sluggish economic growth following the financial crisis. This has caused them to delay business investment. Chart 2 shows a survey of manufacturing CEOs on the likelihood of investing in their business within the next six months. As can be seen, management’s likelihood to invest has risen (along with the recent signs of economic improvement). Business-investment expectations have been trending upward since the summer of 2016, and the current reading of 43 percent is the highest since 1987. This is likely due to the fact that investment has been put off for so long that manufacturers have significant pent-up demand for updating, and possibly expanding, their operations.

We believe that continued recovery in the manufacturing sector will benefit domestic economic growth. The lack of investment by manufacturing firms has acted as a drag on the economy, but signs of the recovered willingness of management to invest point to improved economic expansion. Risks to the manufacturing recovery do exist. Further appreciation of the U.S. dollar, and any event that would reduce global trade, will negatively impact manufacturers and act as a further drag on economic growth. However, in the near term, we see a gradual and ongoing recovery in global trade, reinforced by stable commodity prices. Stronger global demand, especially for U.S. goods used in producing oil and gas, should result in orders for U.S. goods that are strong enough to offset the moderate U.S.-dollar appreciation that we anticipate. At this time, we maintain our U.S. economic growth forecast of 2.1 percent for 2017.

Chart 2. Manufacturing CEOs’ Increasing Expectations of Business InvestmentChart 2. Manufacturing CEOs’ Increasing Expectations of Business InvestmentSource: Philadelphia Federal Reserve, Wells Fargo Investment Institute, 1/6/17. CapEx is capital expenditures.
Note: Survey of manufacturing CEOs expecting to increase capital expenditures over the next six months.

The lack of business investment has been a drag on economic growth in recent quarters. There have been signs that business investment is showing signs of becoming a positive contributor to growth, or, at the least, no longer detracting from economic expansion. Nonresidential fixed investment, a proxy for overall business investment, grew 1.4 percent in the third quarter after rising by 1.0 percent in the previous quarter. Although manufacturing only accounts for roughly 12 percent of the U.S. economy, a pickup in investment in this sector will have a positive effect on economic growth.

Investor Implications

These positive signs indicate a perceptible recovery, and one that should balance economic growth, but we do not expect a manufacturing surge. Since 2014, the U.S. economy has grown in a one-sided way— driven by consumer spending. The recovery in manufacturing broadens the recovery beyond services and should reinforce consumer spending and wage growth. Yet, consumers have not yet shown themselves willing to assume large new debts. Additionally, many countries around the world also are still struggling with debt. Bottom line: Even a gradual manufacturing recovery is another sign that the domestic economy continues to broaden its expansion. This breadth should sustain the U.S. economic recovery into at least the coming year and possibly beyond.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII) WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

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