Economic growth in the US is strong right now. We'll get more evidence with the April jobs report later this week, which could show as many as two million more jobs created. But an important manufacturing survey released on Monday suggests that the fastest growth may be behind us. Even though the expansion is likely to continue, this as-good-as-it-gets indicator could spell trouble for markets the same way it did in March 2010 of the last economic cycle.
The ISM manufacturing survey is a bellwether report showing sentiment among factory owners. A reading above 50 indicates growth, while a reading below 50 signals contraction. Its April reading of 60.7 was historically-strong, but down 4 points from March, which was the highest since the early 1980's.
Being slightly down from a generational high is unquestionably still good if you're a factory worker or anyone rooting for an increase in manufacturing activity. But investors have their own logic when it comes to economic data, particularly early in an economic cycle.
In the early part of an economic cycle, companies curtail production, depleting inventories, in response to a slump in demand. Then, as demand returns, they bring production back online to meet and replenish inventories. That catch-up phase is often the most robust part of the cycle as the economy races to normalize. It also tends to involve shortages, price increases and supply chain problems as companies shift gears during chaotic times. It happened in 2010, and it's happening now.
Once that initial growth spurt is over, economic activity tends to stabilize and growth is more dependent upon what the future looks like rather than merely getting back to its pre-downturn state. Restocking inventories is easier growth than building new factories or distribution centers in a bet on future demand.
Investors tend to get caught flat-footed when this transition happens, which leads to a reshuffling in markets as they acclimate to the normalized economic environment.
That's what happened when the ISM manufacturing index had its short-term peak in March, 2010 — over the next 18 months the S&P 500 actually fell, despite the economy and corporate earnings continuing to grow. From the perspective of 2021, the spring of 2010 was early in the expansion, but it was the end of the initial recovery, and it took markets awhile to absorb that.
That might be where we are now. The stimulative effect of pandemic relief measures will probably fade over time. The vaccination rate in the US is falling, and we'll have harvested most of the gains that come from economic reopening over the next couple of months. Housing affordability continues to worsen, which will become a headwind to the economy eventually. Supply chain problems and higher prices in commodities like lumber will make growth more difficult in the short-term.
And investors could turn their attention to new issues on the horizon. The impact of increasing taxes on corporations and the wealthy may matter more to markets in the short-term than the longer-term impact of infrastructure spending. The spike in inflation we're likely to get this summer may not prove to be transitory. Focus will shift to the timing of the wind-down of the Federal Reserve's asset purchases and an interest rate increase.
If there's one encouraging difference between 2021 and 2010, it's that the international growth picture is likely to improve over the next several months, a stark contrast to when European banks and sovereign debt were causing havoc in global markets. Economic reopening and vaccinations may have peaked in the US but they're likely to accelerate in Europe and emerging markets over the next couple quarters. Even so, that will probably mean other places are growing faster than the US.
In any case, in America, the pace of economic growth is likely going to start to slow from here. This is as good as it gets. Don't be surprised if it takes investors awhile to adjust to that, even if prospects for workers continue to improve for the foreseeable future.
Bloomberg
