Column-Markets torn apart by US factory-services divide: Mike Dolan By Reuters

By Mike Dolan

LONDON (Reuters) – The stark divide between the performance of the U.S. manufacturing sector and the more dominant services sector is giving stock markets headaches at a critical time.

Investors, desperate to gauge the economic mood amid resurgent recession fears, are poring over monthly business surveys for signs of a recession. But what factories and service firms are saying right now seems a different distance apart.

US manufacturers continue to report declines in overall activity, as they have for much of the past two years amid interest rate tightening. Surveys from both ISM and S&P Global agreed on this in August, with dark clouds in China and Europe appearing to affect the factory sector.

The negativity was underscored by an eye-catching detail in the ISM manufacturing survey: a big jump in reported inventories. The increase in August was the first increase in 18 months.

But on the other hand, the largely domestically oriented services sector – which accounts for more than 75% of US GDP – painted a much brighter picture.

The S&P Global survey of US services for August posted the fastest pace of expansion since the Federal Reserve began raising interest rates in March 2022.

As a result, the S&P Global reading for all industries is currently performing well, near its best levels in more than two years.

CANARY IN THE DATA MINE?

While the manufacturing sector accounts for only about 10% of US national output, gloom in the manufacturing PMI surveys was cited as a cause of the jolt to higher US stock prices this week.

This uneasiness may reflect the fact that manufacturing readings now capture information about the chipmakers so prominent in the global market capitalization of the major stock indexes.

Even though the U.S. share of global chip production is currently only 10 percent, the information technology sector — which includes many large chip makers — now accounts for nearly a third of the entire $46 trillion market value.

And Washington’s post-pandemic push for “re-shoring” and “re-industrialization” has helped, through the 2022 CHIPS act, boost optimism about US manufacturing, setting a course for US chip market share to rise to 14% until 2032. .

So sour production readings may feed into the simmering concern about the durability of the dominant AI theme and thus lead to continued market turmoil.

FACTORY HEAD?

Market volatility aside, what the split between the prevailing wealth of the two different parts of the economy says about true recession risk is an open question.

While manufacturing is a low share of US GDP and employs only 8% of US workers, its notoriously cyclical nature means it could be seen as a canary in the coal mine. And it is certainly more sensitive to the state of the global economy in general than to services.

But even if we consider the production studies to be a warning sign, they are not yet flashing red. While August’s ISM reading showed declining activity for the fifth consecutive month, the ISM itself argues that a manufacturing index below the boom-bret 50 line is not necessarily a game changer in itself.

It insists that readings above the 42.5 level – which has not been breached since April 2020 – have over time indicated continued expansion in the wider economy.

Add to all this the dominance of services and their relative buoyancy in the late summer period, and it’s clear why investors – while becoming cautious – are reluctant to bet hard on a broader recession.

All speculation then turns to Friday’s employment report to confirm signs of labor market weakness seeping in from both surveys, as well as the opening and layoff data from earlier in the week.

As if reflecting the indecision, the two-year inversion of the two-year Treasury yield curve — so often a precursor to recession in the past — returned to exactly zero this week in anticipation of the jobs report that could go into sort of tipping the scales to one side.

The opinions expressed here are those of the author, columnist at Reuters

(By Mike Dolan; Editing by Jamie Freed)