Conclusion: The math would suggest it is prudent to fade bullish manufacturing and export data at these prices, given their low predictive value for economic growth. Growth Slowing remains our fundamental outlook for the U.S. economy over the intermediate term.
Position: Long L/T U.S. Treasury Bonds (ETF: TLT).
But manufacturing is strong, right? Right.
Long before today’s ISM Manufacturing beat (76 years ago to be exact), John Maynard Keynes published The General Theory of Employment, Interest and Money. In that seminal work, Keynes laid the foundation for many economists after him to justify currency debasement in order to stimulate an economy’s manufacturing and export sectors in the pursuit of higher rates of GDP and employment growth.
Fast forward to 2012, we are entrenched in what Jim Rickards has labeled “Currency Wars” (also the title of his new book), whereby countries all over the world are pursing expansionary fiscal and monetary policy with the goal (stated or obfuscated) of having the cheapest currency. In few places is this more prevalent than the U.S., where the political agenda continues to be focused on stimulating manufacturing and export growth.
As we’ve seen with the resilience of the manufacturing sector in both the ISM survey and in the monthly employment figures, Obama and Bernanke are getting exactly what they want:
Unfortunately, their “victory” comes largely at the expense of domestic purchasing power and economic/financial market stability (refer to our 2Q12 Macro Themes presentation for more details). Perhaps more importantly, it should be duly noted that stimulating manufacturing and export growth in the U.S. is as good of a real world example of “focusing on the trees in lieu of the forest” as we can find. Manufacturing value added represents only 12.3% of the U.S. economy – down from 20.8% just over 30yrs ago. Additionally, that 12.3% is well below the OECD average of 16.1%.
Turning to exports, outbound shipments have averaged just 13.4% of the U.S. economy over the last four quarters – hardly comparable to the 70.7% share garnered by PCE.
Perhaps these data points explain why manufacturing has had little predictive value in determining U.S. growth. In the analysis below, we regressed the QoQ % change of the quarterly average of the ISM Manufacturing Report on Business with U.S. Real GDP QoQ SAAR – in concurrent fashion and with a one-quarter lag. Needless to say, the fit isn’t tight at all; we’d argue that this is because manufacturing doesn’t move the needle on the slope of U.S. growth. Manufacturing does, however, move the needle on the slope of consensus storytelling about the U.S. economy – as evidenced by today’s melt-up.
As such, we are sticking with our process and siding with the Treasury bond market rather than what we see as a topping equity market, as the former continues to trade in line with our call for slowing domestic growth. Our quantitative risk management levels on 10yr yields are included in the chart below.