The global economy hasn’t experienced a “real” manufacturing cycle in almost a decade due to a series of unfortunate events: first an oil price collapse, then trade wars, Covid, supply-chain chaos and finally abrupt interest rate hikes.
So, when a few months ago a closely watched indicator of manufacturing activity (the ISM PMI index) turned positive for the first time in almost a year and a half, some suggest it could be signalling a long-awaited manufacturing cycle.
“We haven’t had a real cycle for about eight years, which is worth paying attention to,” Tom Riley, head of global thematic strategies and portfolio manager at AXA IM told FSA in an interview.
There has historically been a strong link between manufacturing PMI numbers and the year-on-year earnings growth of the S&P 500 index.
“This may sound quite obvious but as the economy gets better, as the manufacturing sector gets better, there’s better earnings growth associated with that,” Riley (pictured) explained.
“Over the last 25 years this has turned positive seven times and on average the return of the S&P 500 has been 22% higher one year later, and every time it has been double digit positive.”
But what is interesting about this potential new manufacturing cycle upswing is that it is underpinned by three US legislative acts with roughly $2trn of capital committed: the Infrastructure Investment and Jobs Act (IIJA), the CHIPS and Science Act and the Inflation Reduction Act (IRA).
“There was a lot of excitement about them two years ago when they were signed into law, but in reality, relatively little of that has flowed through into the economy thus far,” Riley said.
“The latest data I’ve seen is probably less than 10% of that has been spent so far and it is anticipated to peak in 2026.”
Although the spending will continue beyond then, manufacturing is set to receive more government support over the next couple of years and it is finally starting now to show.
The most lucrative entry point for investors
“There is a relatively long timeframe from these acts being signed to it coming,” Riley said. “But it is coming.”
He noted that capital expenditure for construction spend on the semiconductor industry has ticked up to over $20bn and he expects this to stay elevated for a few years.
In addition to the enthusiasm around AI, the semiconductor industry is an area of key strategic importance to both the US and China who are racing to develop the latest technology, helping fuel an influx of capital investment.
But as manufacturing activity starts to pick up significantly elsewhere beyond the semiconductor industry, Riley believes it is a sign that a new manufacturing cycle coming, stimulated by these three US legislative acts.
However, he added: “I don’t want to give you the impression that the industrial economy is booming. But what it has done is it’s come through that bottoming process and it’s starting to recover.”
“During the recovery phase, historically that has been the most lucrative phase for investors.”
“By the time the industrial economy is booming, and everything’s growing very strongly, that’s often well-known and well reflected in share prices –that’s why we’re looking at this space at the moment.”
Encouraging signs from manufacturing suppliers
Riley, who also manages the AXA RoboTech and Evolving Trends strategies, highlighted the record sales delivered by Keyence, the Japanese-listed industrial automation equipment and solutions supplier as another indication.
The company, which supplies manufacturers globally, noted that capital investments are starting to recover. This helped drive strong orders for its factory automation products.
Speaking to the significance of the strong results, Riley said: “It was record sales and record profits, whilst we’re at the bottom of an automation cycle.”
“What I don’t yet know is what the shape of that recovery looks like, but they [Keyence] are pretty well positioned from a larger perspective to participate in,” he added.
He said the big unknown for the industry is what the shape of the manufacturing recovery will look like.
“We believe that we’re past the bottom,” he said. “Companies are telling us that now.”
For example, companies are indicating that order activity has started to pick up, and that the earliest stage of the funnel client engagements are picking up.
Although there are question marks around whether China will help drive the next manufacturing cycle, Riley noted there are some potential signs of more activity from the region.
But more importantly, he pointed to the “unprecedented support in the US for manufacturing”.
He said: “Maybe the shape of the recovery is a little bit flatter than prior cycles, but maybe it’s a longer cycle because this government support is multi-year in nature.”
