By The Wall Street Journal
This article was originally published in The Wall Street Journal December 1, 2020. We are sharing because it explains why low inventory levels suggest manufacturers can keep increasing output. However, Reuters interpreted the data differently and argued the small drop in manufacturing activity from October to November indicates a sharp economic downturn is on the way. Textile World also published in-depth analysis of the data.
The economy is in for a tough winter. But the manufacturing sector appears to have the wherewithal to push through it.
The Institute for Supply Management said Tuesday that its index of manufacturing activity came in at 57.5 in November—a bit below the two-year high of 59.3 it registered in October, but still a signal that the sector is swinging higher. Anything above 50 indicates an increase in manufacturing activity.
The ISM’s manufacturing gauge is a diffusion index, based on how many manufacturers say activity is expanding versus contracting, so it doesn’t directly measure manufacturing output. A separate Federal Reserve index does, however, and it shows that as of October manufacturing production was about 4.6% below its level before the pandemic struck in February.
That is somewhat curious considering that, adjusted for inflation, consumer spending in October was only 2.2% shy of its February mark, according to the Commerce Department. And consumer spending on goods—the stuff that manufacturers produce—was actually 8.4% higher.
A big reason for this disconnect is probably that manufacturers’ customers have been drawing down inventories to keep up with demand. Indeed, a separate index in Tuesday’s ISM report showed that manufacturers believe their customers’ inventory levels are “too low” to the most extreme degree in over a decade. So even if final demand didn’t rise any further, manufacturers would still need to step up output to bring inventories back into balance.
That dynamic could help insulate them from what is looking like a tough winter. With Covid-19 cases rising and government support fading, it already looks as if consumer spending is starting to falter. With vaccines unlikely to become widely available until the spring at the earliest, some economists are now forecasting gross domestic product to register a slight contraction in the first quarter.
Furthermore, while manufacturers’ customers could be in for a difficult spell in the first quarter, they will also have to consider the jump in demand they are likely to experience after vaccines become widely available. Even if business slows, they might want to start stocking their shelves a little more now.
The winter will be a dark season for the economy, but manufacturing could be a bright spot.