January 11, 2016

Economics Group
Special Commentary
Tim Quinlan, Economist

tim.quinlan@wellfargo.com (704) 410-3283

Sarah House, Economist

sarah.house@wellfargo.com (704) 410-3282

Is the Manufacturing Industry In a Recession?

Executive Summary

The combined effects of a strong U.S. dollar, tepid foreign demand and plunging commodity
prices have the U.S. manufacturing sector up against the ropes. The one-two punch of back-toback contractionary readings from the ISM manufacturing index sets back that bellwether of the
factory sector to its worst reading since the recession. It is not just the ISM. Many of the regional
purchasing manager surveys have been in contraction territory for the better part of the past year.
The soft data from these surveys are underscored by hard data, which has revealed an outright
decline in factory orders and a string of weak industrial production figures in recent months.
Manufacturing is in recession! we hear repeatedly these days. Against the backdrop just
described, that is a claim that generally goes unchallenged.
There is no doubt the manufacturing sector is struggling. Tepid growth overseas and the sharp
appreciation of the dollar over the past year and have sapped demand for exports. The plunge in
oil prices over the same period has led to a sharp decline in machinery and other mining related
equipment. Both of these headwinds have emerged against a backdrop of a historically weak U.S.
expansion, which has left limited impetus for robust capital spending in the domestic economy.
Manufacturing is a major driver of economic cycles in the United States, so the question of
whether or not the sector is in recession merits serious consideration. In this report, we take the
criteria used by the National Bureau of Economic Research (NBER) when determining economywide recessions and adapt it specifically to the manufacturing sector. By this method, factory
activity is clearly in a rough patch, but we would stop short of declaring a manufacturing
recession. As manufacturing recessions have historically led economy-wide recessions, this
should allay fears that the recent weakness in the industrial sector has the broader economy on
the precipice of recession.

Framework for Determining a Manufacturing Recession

Defining a recession could be considered more art than science. Back-to-back declines in GDP
growth is one oft-cited guideline but most economists take a wider range of measures into
account. The NBER Business Cycle Dating Committee is the arbiter of U.S. recessions. It bases
business cycle turning points not only on GDP, but also four key variables: employment,
industrial production, real sales and real income. 1 The 2001 recession makes a good case for
taking a broader scope; GDP did not fall in consecutive quarters, but employment and production
clearly contracted.
To evaluate whether the manufacturing sector is indeed in a recession, we extend the NBERs
approach to the industry level. Quarterly GDP data by industry is published with about a four
month lag, with data only going back to 2005. The other four variables, however, can be found or
constructed for the manufacturing industry at a monthly frequency with up to only about a one
month lag. This provides, in our view, a timely and more thorough look at the state of the
manufacturing sector beyond the widely watched ISM manufacturing report.

See http://www.nber.org/cycles/recessions.html for more details.

This report is available on wellsfargo.com/economics and on Bloomberg WFRE.

We would stop
short of
declaring a
manufacturing
recession.

Is the Manufacturing Industry In a Recession?

January 11, 2016

Manufacturing
production hit a
fresh cycle high
in November.

WELLS FARGO SECURITIES, LLC

ECONOMICS GROUP

Manufacturing Production: Still Trudging Higher

The importance of the industrial sector in driving turning points in the economy is demonstrated
by the use of industrial production (IP) in the NBER committees dating processes. Already
measured in volume terms, IP provides a gauge of real output. Industrial production fell for the
third consecutive month in November, but has been weighed down in recent months by
unseasonably warm weather crimping demand for utilities and, over the past year or more, by
declines in mining output as oil prices have cratered. Looking solely at the manufacturing sector,
production hit a fresh cycle high in November (Figure 1).
To be sure, manufacturing production has not exactly been at its finest form in recent months.
Gains have been weaker of late, with output up just 1.0 percent from a year ago. Slowdowns of
this magnitude, however, do not always portend future declines in output, as evidenced by the
episodes of 1985, 2003 and 2012-2013 (Figure 2).
Figure 1

Figure 2

Industrial Production: Manufacturing

Manufacturing Production Growth

Output Growth by Volume

Index 2012=100

110

110

105

105

100

100

95

95

90

90

85

85

80

80

75

75

70

70

65

65
Economy-Wide Recession

60
55

92

94

96

98

00

02

04

06

08

10

12

14

15%

10%

10%

5%

5%

0%

0%

-5%

-5%

-10%

-10%

-15%

-15%

60

Manufacturing: Nov @ 107.0

90

15%

16

55

Production (Yr/Yr Percent Change): Nov @ 1.0%

-20%

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16

-20%

Source: Federal Reserve Board and Wells Fargo Securities, LLC

Employment: Edging Lower, but Not For the First Time

Employment paints a slightly more anemic picture of manufacturing activity (Figure 3).
Manufacturing payrolls have dipped in August and September, but have actually increased in
each of the past three months. The cutbacks have thus far been pretty minimal compared to the
structural declines stemming from a more capital intensive manufacturing process and greater
global competition over recent decades (Figure 4). Juxtaposed against the upward trend in
production, the downward secular trend in jobs highlights that with productivity gains, it takes
more than a drop in employment to reduce real activity in this industry.
Figure 3

Figure 4
Manufacturing Employment Growth

Employment: Manufacturing
Index 2012=100

155

155

145

145

135

135

125

125

115

115

105

105
Economy-Wide Recession
Manufacturing Employment: Dec @ 103.4

95

90

92

94

96

98

00

02

04

06

08

10

12

14

16

95

10%

10%

5%

5%

0%

0%

-5%

-5%

-10%

-10%

-15%

-15%

-20%

-25%

3-Month Annualized Rate: Dec @ 0.4%

Year-over-Year Percent Change: Dec @ 0.2%
70

74

78

Source: U.S. Department of Labor and Wells Fargo Securities, LLC

82

86

90

94

98

02

06

10

14

-20%

-25%

Is the Manufacturing Industry In a Recession?

January 11, 2016

WELLS FARGO SECURITIES, LLC

ECONOMICS GROUP

Real Income: Better Than the Prior Cycle

In determining the dates of economy-wide recessions, the NBER uses real personal income less
transfer payments as one input. This would include proprietors income, rental income, income
on assets and labor compensation. While income that can be directly tied to the manufacturing
sector is not available for the first three types of income sources, we can estimate real labor
income derived from manufacturing through average weekly earnings and payroll levels. Our
estimate of real wages earned from manufacturing shows real income growth has stumbled, but
not rolled over (Figure 5). In the prior expansion between 2002 and 2008, manufacturing
workers saw real income decline on trend throughout that period. In contrast, real income in
manufacturing has generally improved in the six years since the economy turned in 2009.

Real income has

stumbled but not
rolled over.

Figure 6

Figure 5
Real Income: Manufacturing

Real Manufacturing Sales

Index 2012=100

150

150

Index 2012=100

115

115

Economy-Wide Recession
Real Income: Nov @ 105.0
140

140

130

130

120

120

110

110

100

100

110

110

105

105

100

100

95

95

90

90

85

85
Economy-Wide Recession

80

80

BEA Deflated: Oct @ 105.8

PPI Deflated: Nov @ 100.4

90

90

92

94

96

98

00

02

04

06

08

10

12

14

16

90

75

92

94

96

98

00

02

04

06

08

10

12

14

16

75

Source: U.S. Department of Labor, U.S. Department of Commerce and Wells Fargo Securities, LLC

Real Sales: Looks More Like Mid- to Late-Cycle Slowdown Rather Than Recession
Factory orders and shipments have been some of the bleakest readings on manufacturing activity
over the past year. Shipments, the industrys sales measure, have fallen in four out of the past five
months and are down nearly four percent year-over-year. Values, however, are reported in
nominal terms and have gotten crushed by falling commodity prices. Adjusting for inflation
shows sales activity is not nearly as dire. Using the BEAs price deflator for manufacturing sales,
real sales continue to trend higher and are up 2.0 percent over the past year. The BEAs deflator,
however, has a relatively short history. Adjusting sales using the Producer Price Index (PPI) for
finished goods looks a bit more troubling. Real sales deflated by the PPI peaked in July of 2014
and have since trended lower. Splitting the difference between the two deflated measures, real
sales are consistent with a mid-cycle slowdown, but not an outright decline in real activity.

Four Variables Say This Is Not a Recession in Manufacturing

To determine an industry recession based on these figures, we average the four manufacturing
indices on production, employment, real income and real sales with equal weighting (all indexed
to 2012). Like any measure of activity, there can be small volatility in the short term, so we look
for prolonged periods of declining activity before declaring a manufacturing recession. Even
using the more severe PPI-adjusted measure for real sales, industry activity has stalled but not
declined (Figure 7). Periods of flat manufacturing activity have not always been followed by an
industry recession. As we saw in 1993, 1996, 1998 and 2012-13, growth resumed after pausing
mid-cycle.

Manufacturing
activity has
stalled by our
measure but not
recessed.

Manufacturing recessions have led the previous two national recessions by eleven and four
months, respectively. The fact that real manufacturing activity is not at this point in decline
should allay concerns over an imminent U.S. recession. It is also worth noting that there have
been previous episodes of manufacturing recessions that have not led to a broad recession in the
economy. Manufacturing experienced a double-dip recession in 2003, and, while real sales figures
are not available pre-1992, an average of the three remaining indices shows an industry recession

Is the Manufacturing Industry In a Recession?

January 11, 2016

WELLS FARGO SECURITIES, LLC

ECONOMICS GROUP

in 1985-1986 (Figure 8). These two manufacturing recessions were driven in large part by
pronounced weakness in employment and labor income. Manufacturing production, however, did
not fall thanks to advances in productivity. As such, further weakness in real sales or a sustained
drop in manufacturing production would be a more worrisome sign in our view that the current
softness in manufacturing could portend of a broader recession.
We value the insight provided by the ISM index and other surveys of purchasing managers, but it
would be a mistake to read too much into a contractionary reading. The ISM manufacturing index
often slips into contraction territory even when the economy is doing fine. We looked at ISM
readings back to 1980, excluding all recession periods and looking only at expansions. What we
found is that the ISM manufacturing index is contraction territory 21.4 percent of the time.
Figure 7

Figure 8

Manufacturing Recession Index - Four Variable

Average of Manufacturing Industrial Production, Sales, Employment
& Labor Income, 2012=100

Manufacturing Recession Index - Three Variable

Average of Manufacturing Industrial Production, Employment & Labor

Income, 2012=100

125

130

120

120

125

125

115

115

120

120

110

110

115

115

105

105

110

110

100

100

105

105

95

100

100

90

95

125

95
90
85

Economy-Wide Recession
Recession Indicator Average: Nov @ 103.9
90

92

94

96

98

00

02

04

06

130

95

Economy-Wide Recession
Avg. of Production, Employment & Income: Nov @ 105.1

08

10

12

14

85

90

72

75

78

81

84

87

90

93

96

99

02

05

08

11

14

90

Source: Federal Reserve Board, U.S. Department of Labor & Commerce and Wells Fargo Securities, LLC

But What About Mining?

As we have mentioned, the industrial sector historically has been a key driver of the economic
cycle. A broader look at the industrial sector would need to include the mining industry. Mining
was a key driver of broader industrial production growth from 2010 to 2014, but has been a
significant drag since about the time that oil prices turned south in the middle of 2014. While
even the weak levels of manufacturing activity are not consistent with an industry recession, the
mining sector is a different story. Employment is down 15 percent since peaking a year ago and is
back to levels last seen in 2011. Real income from the mining sector is down 19 percent over the
past year, and production is off 10 percent from the all-time high set last December.
Importantly, the size and influence of the mining sector on the broader economy are much more
muted than the manufacturing industry. In 2014, the mining industry accounted for 2.6 percent
of value added in the U.S. economy compared to 12.1 percent for the manufacturing sector. The
fairly concentrated geographic footprint of the mining industry means that the industrys
recession has been devastating to some parts of the country. However, the small size relative to
the overall U.S. economy means that the mining industry can fall into a recession without taking
down the rest of the economy with it, as we saw in the mid-1980s and again in the late 1990s.

Bottom Line: Stall Speed but Not Currently in a Recession

Periods of flat
manufacturing
activity have not
always been
followed by an
industry
recession.

There is an old joke about the economist who correctly predicted five out of the prior three
recessions. Something similar can be said about slowdowns in the manufacturing sector.
Recessions in manufacturing (using the definition we establish in this paper) have offered an
early warning ahead of the recessions for the broader economy in 2001 and 2009. However, a
manufacturing recession can also be a head-fake as it was in the manufacturing recessions of the
mid-1980s and in 2003. In each of these occasions, the broader economy continued to expand
despite the headwinds confronting the manufacturing sector.

Is the Manufacturing Industry In a Recession?

January 11, 2016

WELLS FARGO SECURITIES, LLC

ECONOMICS GROUP

Moreover, despite the litany of negative news for manufacturing, our analysis of the four key
variables makes clear that these challenges do not amount to a manufacturing recession. On that
basis the rampant concerns about a manufacturing led recession are overblown, at least at this
point, in our view.

Wells Fargo Securities, LLC Economics Group

Diane Schumaker-Krieg

Global Head of Research,

Economics & Strategy

(704) 410-1801
(212) 214-5070

diane.schumaker@wellsfargo.com

John E. Silvia, Ph.D.

Chief Economist

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Mark Vitner

Senior Economist

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Jay H. Bryson, Ph.D.

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Eugenio J. Alemn, Ph.D.

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Anika R. Khan

Senior Economist

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Azhar Iqbal

Econometrician

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Tim Quinlan

Economist

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Eric Viloria, CFA

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Sarah House

Economist

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Michael A. Brown

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Erik Nelson

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