Dip in ISM manufacturing insignificant to S&P 500

The Fed is expected to maintain an accommodative policy stance in such an environment, and this will benefit “income equities” such as Asia REITs.
Chief Investment Office04 Sep 2019
Photo credit: AFP Photo

What happened?

ISM Manufacturing Index fell below the 50-mark in August; US-China trade war weighs on manufacturing activities. The ISM Manufacturing Index came in sharply below market expectations at 49.1 in August (vs consensus forecast of 51.3), a level which suggests that manufacturing activities in the US are in contractionary mode. This is the first time the index has breached the “50-mark”, underscoring the detrimental effects of the ongoing US-China trade war. On a component basis, the weakness was evident across the board with declines seen in production, new orders, and unemployment.

What does this mean?

Insignificance of US manufacturing to domestic economy; Limited impact on S&P 500. Given recent escalation on the trade front, a slowdown in US manufacturing activities is expected. But to put things in perspective, manufacturing now accounts for only c.11% of US economic output – a marked departure from the 1970s when manufacturing accounted for approximately double the current level.

Nonetheless, the situation is not static. Should the manufacturing decline translate into unemployment, and by extension weaker consumer confidence, the second order effects on the economy can be material. That said, this is not our base-case scenario given that manufacturing accounts for an insignificant proportion of US jobs creation these days.

Manufacturing weakness translating to (a) More monetary accommodation and (b) Greater urgency on trade deal? The upshot of this manufacturing data weakness is that the US Federal Reserve will be more compelled to maintain its accommodative stance in the coming months to support the economy (Figure 1). More importantly, broad-based weakness in manufacturing may also compel US President Donald Trump to lighten up on his trade negotiation antics. Remember, Trump has promised to bring back manufacturing jobs to the US and the latest ISM manufacturing data runs counter to this promise.

What should you do?

Benefit from dovish Fed; Ride the wave with “income equities”. With the Fed highly expected to maintain its dovish stance, investors should ride this wave by gaining exposure to “income equities”, in particular Asia REITs. On a year-to-date basis, Asia REITs have outperformed global equities by 6%pts and we expect this outperformance to persist (Figure 2).

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