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Can Manufacturing Keep Stocks Afloat? 

Kristina Hooper 

The Upshot 

11/4/2013 

A Fed-fueled stock rally may cool as economic weakness and Washington dysfunction filter into quarterly earnings forecasts. But surprisingly robust expansion in the manufacturing sector could hold the line against recent setbacks, writes Kristina Hooper.
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Kristina Hooper, US Investment Strategist and Head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

The missing piece of the growth puzzle may be found in our nation’s factories.

The Fed’s easy-money policy has sent stocks soaring in 2013 despite a lukewarm economic recovery, distressed labor-market conditions and countless political dustups in Washington. But when you start to see a lot of disappointing economic data, it’s time to consider that the market may soon come back to earth. However, US manufacturing has been staging a comeback and could cushion the blow of pared profit forecasts and a string of discouraging economic news.

Among companies that have issued fourth-quarter earnings guidance, 84% have issued negative guidance, well above the five-year average of 63%.”

On Wall Street, the Dow and the S&P 500 rose again last week, marking the fourth consecutive week of gains, although small caps and tech stocks posted losses. Treasury yields rose on fears that Fed tapering could happen sooner than the market now expects. Many market observers are scratching their heads, wondering what’s propelling US large-cap stocks higher when there are so many reasons for them to trade lower. Indeed, the weak data we’ve seen lately should be exerting a gravitational pull on stocks. Here are four areas where we’ve seen discouraging developments:

The housing recovery is stalling. While the August S&P Case-Shiller Home Price Index showed a gain slightly higher than expectations—the first monthly increase since April—most indicators show that housing has slowed significantly. For example, September existing home sales fell 5.6%, well below estimates and the revised August number. It marked the fourth straight drop in pending home sales and illustrates the damage done by a sizable drop in housing affordability.
The job market has taken a turn for the worse. Initial jobless claims released last week dropped to 340,000, but remain at an elevated level relative to what we saw in the months before the shutdown. In addition, the September employment report released several weeks ago and the October ADP private employment report released last week showed softness. Economists expect a lackluster jobs report this Friday, especially given that the ADP report has become a much more reliable indicator of private job growth in the past year.
The government shutdown has shattered consumer confidence. In the last week, the Conference Board’s consumer confidence index dropped substantially. But the loss of confidence hasn’t been limited to consumers; it seems to have hurt institutional investor confidence, as measured by the State Street Investor Confidence Index, which views weightings to equities as a proxy for confidence. While institutional investor confidence is increasing in Europe, it has dropped dramatically in North America.
The fourth-quarter earnings outlook is cause for concern. While most investors are still focused on third-quarter profits, they should pay more attention to how the government shutdown has impacted next quarter’s earnings. Of the 79 companies that have issued earnings guidance for the fourth quarter, 66, or 84%, have issued negative earnings guidance. According to Factset, this percentage is well above the five-year average of 63%.

Manufacturing Revival

But the data’s not all bad. The one bright spot right now seems to be manufacturing. In fact, it was a strong October ISM manufacturing report that moved stocks higher last Friday. At 56.4, it beat consensus expectations and edged above the previous month’s reading. Specifically, new orders posted their third consecutive reading above 60 while production posted its fourth straight reading over 60. Employment, while slowing, indicated expansion in the labor market for the fourth consecutive month, albeit at a slower rate than in September. We’re even seeing a healthy increase in backlog orders.

Business Buying Spree


To put it in a larger context, the ISM manufacturing report has a unique origin: it was first published in 1931 in response to President Herbert Hoover’s request for a timely measure of the factory sector given its importance to the overall economy. Since then, US manufacturing has been on the decline, but the ISM Manufacturing Index—a survey of purchasing managers at US corporations—is still a key benchmark. And manufacturing has experienced a mini-resurgence recently due to lower energy costs from natural gas, relatively attractive labor costs and a strengthening dollar. That breeds hope that manufacturing can contribute to a stronger US economy over the longer term. In fact, Boston Consulting Group expects US reindustrialization to add up to five million jobs by 2020.

Manufacturing activity—specifically new orders—shows promise for the US economy.”

The latest national ISM data confirmed the stunning Chicago PMI numbers, which posted their biggest monthly gain in the regional index in more than 30 years. Perhaps there are more positive surprises in store for US manufacturing. Maybe manufacturing expansion can provide the growth handoff needed to sustain the economy after the Fed ends its QE stimulus program. If nothing else, then manufacturing may serve as a boon for the stock market and offset some of the headwinds facing the economy right now.

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The Standard & Poor’s 500 Composite Index (S&P 500) is an unmanaged index that is generally representative of the U.S. stock market.

Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. It is not possible to invest directly in an index.

The S&P/Case-Shiller Home Price Indices are the leading measures for the US residential housing market, tracking changes in the value of residential real estate both nationally as well as in 20 metropolitan regions.

Purchasing Managers’ Indexes (PMI) are economic indicators derived from monthly surveys of private sector companies. The Chicago-PMI survey registers manufacturing and non-manufacturing activity in the Chicago region. Investors care about this indicator because the Chicago region somewhat mirrors the nation in its distribution of manufacturing and non-manufacturing activity.

The Institute of Supply Management (ISM) Manufacturing Index is a composite diffusion index of national manufacturing conditions. Readings above 50 percent indicate an expanding factory sector.

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded blue chip stocks, primarily industrials, but including financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks.

Conference Board Consumer Confidence Index is a survey by the Conference Board that measures how optimistic or pessimistic consumers are with respect to the economy in the near future.

State Street Advisors Consumer Confidence Index measures investor confidence by looking at actual levels of risk taken by investors in their portfolios. The State Street Investor Confidence Index reports on the second-last Tuesday of each month, using data it collected at the close of trading on the previous Wednesday

Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.


A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
 
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 

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