Why the Manufacturing Recovery May Be a Fleeting Event

By Evaldo Albuquerque

The latest data on manufacturing activity, released yesterday morning, fell to levels lower than expected. But who cares, right? As long as the numbers are printing above the 50 boom/bust level, we’re ok. At least, that’s the way the market is interpreting that piece of data.

But what if that manufacturing recovery doesn’t last too long? I think the likelihood of that happening is quite high. A look back on how companies reacted to the crisis may help us understand why.

When the housing bubble burst, most companies cut inventory in a very aggressive manner. After all, they were preparing for an Armageddon scenario. The shelves were so empty, that a very small improvement in demand led to a pick up in manufacturing activity.

In fact, some research shows that historical relationship between GDP and manufacturing suggests that manufacturing should have fallen by about 10% from peak to trough. The actual fall was nearer 20%.

The manufacturing recovery seen so far is just a correction of this undershooting. When this restocking cycle comes to an end next year, manufacturing activity will only be able to keep its pace if consumer demand picks up. With unemployment still on the rise, I don’t see that happening any time soon.

The end of this inventory cycle is just one of the factors that may contribute to a correction in stock market and a consequent dollar rally some time next year.

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