Markets Torn by Divided U.S. Services and Factories: Mike Dolan, Reuters

By Mike Dolan

LONDON – The growing disparity between the performance of the U.S. manufacturing sector and the more dominant services sector is causing challenges for stock markets at a crucial time.

Investors, eager to understand the economic landscape amid renewed recession fears, are closely examining monthly business surveys for hints of a downturn. However, the outlook from factories and service firms appears to be drastically different.

U.S. manufacturers continue to report declines in overall activity, a trend that has persisted for most of the past two years due to rising interest rates. Surveys conducted by both ISM and S&P Global confirmed this decline in August, with concerns surrounding economic performance in China and Europe further impacting the manufacturing sector.

A notable detail from the ISM manufacturing survey was a significant increase in reported inventories, marking the first rise in 18 months.

Conversely, the services sector, which constitutes over 75% of U.S. GDP and primarily serves the domestic market, displayed a much more positive outlook. S&P Global’s services survey for August recorded its fastest rate of expansion since the Federal Reserve began increasing interest rates in March 2022. Consequently, S&P Global’s all-industry reading is currently performing well, approaching its highest levels in more than two years.

While manufacturing makes up only about 10% of U.S. national output, the negative sentiment reflected in manufacturing PMIs has been identified as a factor contributing to the recent volatility in U.S. stock prices.

This turmoil may be partly due to the fact that manufacturing metrics now capture trends from prominent chipmaker companies, which play a crucial role in major stock indices. Despite the U.S. holding just a 10% share of global chip manufacturing, the information technology sector—including several large chipmakers—constitutes nearly one-third of the U.S.’s total market value of $46 trillion.

Washington’s initiatives to promote “re-shoring” and “re-industrialization,” supported by the CHIPS Act last year, have fostered optimism about increasing the U.S. share of the chip market from 10% to 14% by 2032. Thus, poor manufacturing indicators may contribute to worries about the sustainability of the booming artificial intelligence sector, potentially leading to continuous market fluctuations.

As for the implications of this divide, the true risk of recession remains uncertain. Although manufacturing represents a small portion of the U.S. GDP and only employs about 8% of the workforce, its cyclical nature may serve as a warning sign about economic health. Additionally, manufacturing is generally more affected by the global economy than the services sector.

Even if manufacturing surveys are regarded as early warning indicators, they are not yet signaling a critical downturn. The August ISM report indicated a decline in activity for the fifth consecutive month; however, the ISM maintains that an index reading below the threshold of 50 is not necessarily a definitive indicator of significant economic change. The ISM argues that readings above 42.5, which have not been breached since April 2020, historically suggest continued expansion of the broader economy.

Taking into account the dominance of the services sector and its relative resilience observed during the late summer, it is evident why investors—despite growing cautious—are hesitant to make drastic moves in anticipation of a substantial economic downturn.

Consequently, attention is turning to the upcoming employment report, which could offer insights into potential labor market weaknesses hinted at in both manufacturing and services surveys, as well as job openings and layoff data released earlier in the week.

In light of these uncertainties, the inversion in the 2-to-10 year Treasury yield curve—a traditional predictor of recession—has returned to zero this week, as investors await the jobs report, which may influence market direction.

The views expressed herein reflect the opinions of the author, a columnist.