The slowdown in manufacturing is continuing despite some reasons for optimism at the end of the year. There were hopes that the "phase 1" part of the trade deal would lead to some resolution and unleash pent-up demand. Some second-derivative manufacturing data also showed inventories dropping and new orders increasing. This development often coincides with turning points.

At other times, these simply mark plateaus in downtrends, when optimism builds and bullishness increases. Currently, both scenarios remain in play. Recent December manufacturing data failed to confirm a turn in manufacturing. In fact, the PMI dropped to lows last seen in 2011.

Of course, the stock market has been behaving as if the bottom is in with stocks moving to all-time highs. In addition, stocks connected to economic growth have been outperforming as well. How this circumstance plays out will be a major contributor in determining how financial markets fare this year.

One helpful exercise is to compare this current manufacturing slowdown against the previous one from 2015-2016.

Current Situation

Since October 2018, manufacturing has been slowing in the U.S. and across the world. The main factors are the trade war between China and the U.S., a downturn in the business cycle, and continued secular weakness in China. Importantly, weakness in manufacturing has failed to meaningfully affect other parts of the economy which continue to grow although at a slower pace than previous years. Decreased economic activity from this headwind has been more than offset by the increase in economic activity from the stimulative effects of lower interest rates.

From around October 2019, there was increased optimism that the manufacturing headwind was going to become a tailwind which would lead to accelerating economic growth. Stocks discounted this possibility and zoomed higher with cyclical sectors leading. It seems likely that if the manufacturing data fails to affirm this optimism that stocks could tumble.

Previous Slowdown

In some respects, this is exactly what happened in the previous manufacturing slowdown from 2015 to early 2016. From September 2015 to December 2015, stocks rallied furiously, as it seemed that the slowdown was about to end. When it became clear that this wasn't to be, stocks gave up all their gains before double bottoming in February and rallying out of severe, oversold conditions.

However, one major difference between the two scenarios is that the previous slowdown was milder and concentrated in the energy sector. Oil was in a severe bear market from late-2014 to early-2016 as it fell from over $100 to under $30. This resulted in a complete freeze on all types of energy projects which negatively affected manufacturing. This time, weakness in manufacturing is more evenly spread rather than concentrated in a single sector.

Looking Ahead

The 2015-2016 slowdown is a reminder that stocks can drop violently if incoming data fails to confirm the market narrative. A new narrative will emerge which won't be consistent with juicy multiples. Further, this manufacturing slowdown is more widespread, and it's already experienced more of an overall decrease in activity than 2015-2016.