Manufacturing has become a weak spot in a healthy economy

The latest of the very closely watched purchasing managers index readings just confirmed what we have been hearing for a while, that American manufacturing went south pretty much all of last year.

Called the PMI, it's published by the Institute for Supply Management from surveys of people in the supply chains of privately held companies. It reached its 2019 peak last January at a healthy 56.6 and bottomed out for the year in December at 47.2, lower than it has been since 2009, when the economy was in the deep hole of the Great Recession.

One interesting thing about this, though, is that a manufacturing slowdown isn't enough to push the whole economy into reverse. The streak of monthly job growth remains intact at 111 months and the unemployment rate bumps along at a rate last seen five decades ago. And if any reputable economic forecaster thinks the U.S. economy actually contracted in the fourth quarter, I missed it.

But that doesn't mean it's not painful to some in manufacturing. Job growth in "goods producing" businesses has been sliding since 2018 and manufacturing actually shed jobs in December, one headline out of last Friday's closely watched jobs report. Shifts and hours have been cut, and it sure would be good to know why this has happened and how soon the slump might be ending.

One interesting aspect of this whole story is that there's at least one competing indicator more upbeat about manufacturing than the one published by ISM. Yet no one really disputes that a slowdown in the industrial sector has been underway.

Here in the Upper Midwest, reports of the brakes being applied started reaching the regional economic research team at the Federal Reserve Bank of Minneapolis around midyear, said Joe Mahon, regional outreach director for the bank.

"One of the most informative developments that we saw over the second half of 2019 was a lot of the reports I was hearing about a slowdown were from producers of capital equipment," he said. "They were from custom manufacturers … and the manufacturers who sell to other manufacturers. That to me seemed to be more of a leading indicator of a slowdown in manufacturing. And we have started to see some of that borne out in the data now."

It hasn't announced its fourth-quarter results yet, and sales for the company were still growing nicely through the third quarter that ended in September, although the pace of that growth had slowed a lot. The most cyclical product category, fasteners, had daily sales growth of just 3% in the third quarter, vs. nearly 12% back in the first quarter of the year.

The last time company managers provided a lot of commentary was on its conference call with investors and analysts in October, and then management was matter of fact about the slowdown in the industrial economy. The company has since released its monthly sales through the end of November, and the daily sales trend has continued.

The customer segment where growth has slowed the most is heavy equipment. That information squares with what Mahon has heard at the Minneapolis Fed, that what's really being affected are the kinds of products that are built not for consumers but for other businesses that make or ship goods.

The last time there was one of these slowdowns in manufacturing was in 2015 and 2016, also caused by a slowdown in business investment. The main reason then, though, was a decline in oil prices, and that in turn crushed the capital-spending plans of companies that drill for oil.

The top 25 U.S. oil companies cut their spending by almost a third in 2015, then slashed spending again by roughly 40% the following year.

When cuts in capital spending take shape, that makes equipment suppliers pare back on their own capital spending plans for the stuff they use, like new trucks, shop floor machines, computers and so on. That's how a slowdown in the oil patch shows up in a lower sales forecast for a Midwestern producer of heavy-equipment brake components.

The 2019 slowdown has a fundamentally different explanation, and it really is related to the international trade disputes and tariffs. Fastenal CEO Dan Florness put it this way on his company's last call: "The supply chain for our customers has become more expensive in the last one and a half years and more volatile."

The keyword here might be volatile, as business planning and decisionmaking in long manufacturing supply chains amid tariffs and threats of more tariffs became so much harder. When the decisions get tougher to make, Florness said, what starts to look easier is making no decision. That's how a plant expansion gets pushed to next year and put into the following year's preliminary capital spending budget.

As last year ended, though, the chatter from manufacturers in our region seemed to get more positive than it had been earlier, said Mahon of the Minneapolis Fed.

"What I hear a lot is that there's just a lot of uncertainty for 2020," he said. "The phrase I hear over and over again is 'cautious optimism.' They're kind of optimistic that the sector might bounce back, but they're not tremendously confident."

On the other hand, the manufacturing economy seemed to be sliding sideways through the most recent annual season of business planning and budgeting. We have to assume that there were a lot of promising projects at manufacturers in our region that didn't get any money in the 2020 budget.