US manufacturing is not a recession red flag

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Good morning. Nvidia patching continues. The chipmaker’s shares fell 9.5% at the close yesterday. Should CEO Jensen Huang trade his leather jacket for cheap, all-weather denim? Email us: [email protected] and [email protected].

No more worrying about production surveys

The S&P 500 fell more than 2% yesterday. The Financial Times story (and indeed every story) on sales linked the decline to weak manufacturing survey data, which “added to investor concerns about an economic slowdown.”

The survey-based ISM Manufacturing index for August, at 47.2, was barely improved from its dismal July level. The new orders component of the index, considered a leading indicator, fell nearly three points to 44.6. Remember (who would blame you for locking it in?) that July’s weak reading was the initial tremor that, combined with a bad jobs report, became the market’s mini-earthquake of a month ago.

So this seems like a good time to ask how much we should worry about weak manufacturing ISM readings. And the answer is: not much.

Some obvious points to start with. First of all, the August number is not really news. The ISM readings for July and August are not much worse than the figures for the past two years. Yes, the new order count is a multi-year low, but it’s only one month:

Further, it is not obvious that market sales had that much to do with the production ratio. The most notable decliner yesterday was Nvidia, down almost 10%. Nvidia is not a manufacturer and is not particularly sensitive to cyclical trends that affect manufacturers. Broadening the view, the persistently weak signal from the ISM survey has not been picked up by the stock market: industrial stocks have performed well over the past two years.

In theory, we should care about a manufacturing survey—despite the fact that manufacturing accounts for little more than a tenth of US GDP and an even smaller share of employment—because manufacturing can be a leading indicator of demand in other sectors. “If there’s no appetite for manufactured goods in services, retail, mining or construction, that tells you something,” says Skanda Amarnath of Employ America. That said, Amarnath also points out that U.S. manufacturers serve global customers, so ISMs may reflect weak global demand rather than U.S. demand. And uncertainty about the rate cycle and the presidential election could move demand forward rather than destroy it.

If the weak manufacturing ISM reading reflected a low level of investment by domestic customers, we would expect to see this in the GDP investment data. But real investment growth has fallen only slightly (and equipment investment is growing):

Oxford Economics’ Matthew Martin sums it up: “Moving” indicators of sentiment such as surveys and “hard” indicators of manufacturing have broken down in manufacturing. This should not surprise us at a time when consumer sentiment (poor) and consumption (very good, thank you) do not follow each other. He believes that production will recover. Inventory levels are low and will need to increase at some point; lower interest rates should support investment; ending the election one way or another will help confidence; and the Biden administration’s subsidies and other supports for domestic manufacturing continue.

Housing provision

Housing in America is punishingly expensive, and the presidential candidates have noticed. Kamala Harris has promised to increase housing supply by 3 million units. Donald Trump has pledged to lower prices and “protect America’s suburbs.”

If the next president is lucky, falling interest rates will weaken the market. But a real fix requires new supply — and the supply side of the U.S. housing market is largely governed locally, not federally. Local zoning laws tend to focus on maintaining property values ​​and the “feel” of a neighborhood, and therefore often limit new buildings through lengthy approval processes or restrictive policies.

So how can the federal government increase supply? Experts identify four policy routes:

• Financial incentives for building new units. This was accomplished through block grants that help states build new public housing units and the Low Income Housing Tax Credit (LIHTC), which rewards builders of affordable homes. The Harris campaign has proposed a tax incentive for developers who make affordable starter homes. Trump’s campaign made no such promises. But again, developers receiving incentives are governed by local law.

• Influence local zoning. The federal government can incentivize local governments to change their zoning laws. Just last year, the Biden administration launched the Pathways to Removing Obstacles to Housing program, which rewards jurisdictions with up to $10 million for removing laws that limit new construction. The Biden administration and several bills in Congress have also sought to encourage the legalization of new, cheaper types of housing. However, this is largely uncharted territory. From Cornell University’s Sara Bronin, who runs the National Zoning Atlas:

I would argue that we don’t know enough about zoning to be precise about those incentives. . . Current federal programs tend to have very general results; they do not prescribe many specific actions that local governments must take.

And reforming zoning laws is hard even when change is initiated at the local level. From Kate Nelischer of the University of Southern California:

Changing local zoning laws requires lots of professional planners and lengthy community consultation processes that can be contentious. . . It’s not an easy challenge to solve, and there are a lot of (additional) complexities when the federal government works with local and state governments.

• Drive conversions and conversions. The government could encourage the rehabilitation of old houses not currently in use. The Harris-Walz campaign endorsed the neighborhood home tax credit, a Senate proposal to grant tax credits for rehabilitation.

  The federal government could also incentivize the conversion of vacant commercial buildings. The Biden administration included conversions in its action plan, but there is no federal tax incentive on the books — but promoting one can be seen as a boon for real estate investors and therefore politically sensitive.

• Reward sale. Existing home sales make up the bulk of the housing market, and those sales have been frozen by the current fiscal situation. Twenty percent of homes sold are actually net market additions, meaning the owner didn’t buy or rent a new home after the sale, according to John Burns Consulting’s Rick Palacios — either because it was a vacation home or because it was an investment, he then moved in with his family. Revising the current capital gains tax legislation could incentivize multi-property owners to relinquish excess supply to the market. Giving a tax break to families who own multiple homes could be politically complicated, though.

In short: There are things the federal government can do, but local zoning remains the key determinant, and politics is difficult. Any change coming from Washington will be painfully slow.

(Reiter)

A good read

Beijing in Albany.

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