Is the Rising Star of U.S. Manufacturing Fading?

Once the darling of the "recovery," manufacturing faces challenges as the global economy slows.

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Manufacturing has been one of the rare bright spots in the so-called recovery of the U.S. economy, but weakening data for the sector is prompting fears that the rising star of "Made in America" might be fading.

The Institute for Supply Management's factory index, which tracks manufacturing activity, dropped nearly 1 percent in September to 50.8. While that's still technically in expansion territory—values above 50 indicate growth, values below indicate contraction—actual numbers came in weaker than economists expected.

Disappointing ISM numbers coupled with news that Whirlpool Corp., the world's largest household appliance manufacturer, plans to slash 5,000 jobs underscored fears that global manufacturing activity is cooling as consumer demand and spending wane. The Chinese factory index sunk to its lowest level since February, Bloomberg reported, while U.K. manufacturing declined to a 28-month low.

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The biggest drag on U.S. manufacturing came from shrinking inventories, which suggests companies have been paring down inventories due to anxiety about the future. "Typically when inventory turns negative like that, it means that there's lack of confidence in the short term," says David Smith, chief investment officer at Rockland Trust Investment Management Group. "That seems to be the overriding concern right now with all the economic data we're looking at right now."

But for the optimists, lean inventories might not actually be a bad thing, especially since the pullback in inventory was accompanied by an uptick in new orders. "The combination of the two—orders rising while inventories are falling—could create the potential need for additional production in the future to fulfill those new orders," says Michelle Gibley, senior market analyst at Charles Schwab. "Inventories is kind of a lagging [indicator] and new orders is more leading."

Another potential positive for U.S. manufacturing in the longer term is rising wages in China. In the past, low wage rates drove many companies to shift production from the United States to China, but with wage rates growing 15 to 20 percent per year there, China's status as the default low-cost manufacturing location is fading.

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"We've seen in the last 10 years a lot of outsourcing to China, factories closing [in the United States], but wages in China have been rising quite rapidly," says Hal Sirkin, senior partner at the Boston Consulting Group and author of Globality: Competing with Everyone from Everywhere for Everything. "When it was 50 cents an hour compared to $16 or $18 dollars an hour, it was a real easy decision. With wages rising, companies are now looking and saying, 'I'm not so sure [China] is the best place to go.'"

Several American companies have already shifted some of their operations back to the United States. Citing rising costs, Master Lock pulled back some of its production from China to Milwaukee, adding about three dozen jobs in recent years. Coleman has also pared down its operations in China due to costs, moving some production to Wichita, Kan.

The wildcard, of course, is Europe. The shred of certainty generated by the European debt relief deal brokered last week has been all but dashed by news Greece will hold a referendum to determine whether Greek citizens support the debt deal and the austerity measures Athens would have to enact in exchange for bailout funds.

"With headlines like we've seen coming out of Greece, you can totally understand why a businessman doesn't know how to make a decision about what to do with inventories or any long-term planning for that matter, particularly as it pertains to hiring, which is the real crux of the problem," Smith says. "Some clarity out of Europe would be well received."

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The effects of uncertainty about the European sovereign debt crisis are already beginning to materialize. Export orders fell as the probability of the euro zone tipping into recession increases. Coupled with slowing growth in emerging markets, exports momentum has slowed, according to a recent IHS Global Insight report.