Manufacturing is key for earnings and equities
The manufacturing sector has been in recession, but there are now signs of a turn. Chart 1 shows that the manufacturing Purchasing Managers’ Index (PMI) has picked up only a little and from a low base. Despite the recent setback associated with trade tensions, new orders relative to inventory suggest that this recovery will gather pace. Manufacturing is tiny relative to services when it comes to GDP in developed markets, but importantly for financial markets, when it comes to corporate earnings and equities the reverse is true: manufacturing is much more important.
Chart 1: Manufacturing recovery underway
Source: BMO Global Asset Management/ J.P. Morgan as at 13-Jan-20
This turnaround is being led by semiconductors. Last spring this sector was seeing a contraction of around 15% year on year, but the market has begun to turn as the 5G roll-out gets going and by this spring we are likely to be seeing growth rates of 20% or more. A big turnaround.
Moreover, the dramatic pivot by the Fed along with subdued inflation has led to a big improvement in the US housing market with more to come. And when housing is strong, the rest of the economy tends to be strong too.