Factory activity plummeted in August

New data suggests that the US will soon enter recession, if it has not done so already. The figures for the East Coast region shows that factory activity plummeted in August to a level never seen before without the economy being in recession.

Philadelphia leads the way

The index from the Federal Reserve Bank of Philadelphia shows manufacturing output in the Mid-Atlantic region of the US East Coast stood at minus 30.7 in August compared with a gain of 3.2 in July.

The survey was conducted during August 8-16.

The data shows that this month's key purchasing data index from the National Institute for Supply Management could sink as low as 42 from the current figure of 50.9. The close relationship between the two data points is illustrated by the attached graphic. Economists had expected a 1.5 rise in the Philadelphia reading for August.

Any figure of below 50 for the ISM index, due to be released at the beginning of September, indicates the economy is contracting.

That, in turn, would be likely to push down equities. Deutsche Bank strategists said. “Using our often-used relationship between the change in the S&P500 and the ISM this would point to a year on year fall of 22% in US equities. On September 1 last year the S&P 500 was at around 1080 and 22% below this would take us to around 860.”

Things may not get that bad. Deutsche points out that the index hit a low last July and August. A fairer 2010 starting point to calculate a drop could be the beginning of year. This would imply a less frightening drop in the S&P500 to 1000.

Other analysts say the fall in the US equities over the last fortnight has already partly discounted the arrival of recession.

Economists at Germany's Berenberg Bank said current reactions to bad news, or expected bad news, are overdone: "It is the nature of panics and manias that they drive asset prices away from fundamental valuations. For a while, such exaggerations reinforce themselves as investors are inclined to pay more attention to facts, events or mere rumours that seem to justify their current concerns than to longer-run fundamentals.

The Wall Street Journal quotes Eric Green, head of rates research at TD Securities, as expecting a less severe fall in the ISM to between 46 and 47. He said: “We were looking for more weakness on the ISM but nothing like this.”

(Financial News, August 19, 2011)