Following delayed US.-China trade negotiations last week, US President Trump tweeted that he intends to impose a 10 percent tariff starting in the beginning of September on the remaining $300 billion in Chinese imports. It is evident that an additional 10 percent tariff may continue to extend the global downturn in manufacturing.
The global manufacturing purchasing managers index (PMI) is the most broadly used measure of worldwide manufacturing; markets have seen this index fall for a record 15 months in a row.
Rebound or recession
On average, manufacturing cycles last about three years. Studies have shown that activity usually rises for about 18 months, then slides for about 18 months. There are typically three manufacturing cycles per economic cycle. After a recession resets the economic cycle, the first two manufacturing cycles tend to be mild downturns, and the last one tends to lead to broader weakness and result in a recession.
The current pattern of manufacturing suggests one of two outcomes. Since downturns in manufacturing have tended to last about 18 months, an end may be close. The PMI has now declined for 15 months in a row potentially pointing towards a rebound. Alternatively, this decline may align with the end of the overall economic cycle. The PMI may continue to decline another 10 points or so, indicating a global recession.
Manufacturing matters
Earnings are the most important long-term driver of the stock market. Corporate earnings tend to closely sync up with manufacturing cycles, with the PMI leading earnings by nine months.
If corporate earnings are falling, stocks tend to slide also. Markets have seen PMI and stocks move in sync with each other as markets react to the signal on the direction of earnings growth. Significant further downside for the PMI suggests the potential for meaningful losses.
With renewed trade tensions adding further pressure to manufacturing, an upturn may not be likely. In fact, the rate cut by the Fed, which came just before the President announced the new tariff, may have emboldened the U.S. administration to pursue a more aggressive trade policy.
China's response has been to allow their currency to depreciate. This can destabilize markets, with Chinese companies that borrowed in dollars facing a greater debt burden and U.S. companies selling to China having to discount their products, among other impacts that can further darken the outlook for manufacturing.
While there may be no winners in a trade war, by staying out of the fight a country may be able to lessen the collateral damage. In fact, for Europe and Japan, there is no direct hit from the US-China tariffs.
Despite the worrisome global trend in manufacturing, staying as far as possible from the successive waves of trade barriers might offer a relative growth advantage for companies.
A breakthrough in trade talks could eventually relieve trade tensions. However, in the near term, there may be further downside to manufacturing, the outlook for earnings growth and stock prices, raising the risk that this mini-cycle turns into a broad recession.
This article was issued by Maria Fenech, Credit Analyst at Calamatta Cuschieri. For more information visit, https://cc.com.mt/ . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.