The US economy has been a study in contrasts, a tale of two sectors. While the services sector hums with activity, fueled by consumer spending and a robust labor market, the manufacturing sector has been mired in a two-year slump. This divergence has created an uneasy backdrop for the current bull market, leaving investors questioning its sustainability. 

However, a closer look at recent earnings calls reveals a glimmer of hope: whispers of a “bottom” suggest that the manufacturing sector may finally be turning the corner.

A Tale of Two Sectors

The services sector, representing over 70% of the US economy, is undeniably strong. The Institute for Supply Management’s recent report confirms this, showcasing a multi-year high for the sector. Consumers continue to spend, supported by a strong labor market, bolstering industries like hospitality, travel, and entertainment.

Conversely, the manufacturing sector has been grappling with a perfect storm of challenges. Supply chain disruptions, lingering effects of the pandemic, high inflation, and weakened global demand have all contributed to its woes. This stark contrast in performance between the two sectors is the widest it’s been in over two decades, painting a perplexing picture of the US economy.

Whispers of a “Bottom”

Despite the gloom surrounding manufacturing, there are encouraging signs emerging from corporate America. Bank of America’s US Equity and Quant team, led by Savita Subramanian, has observed a notable uptick in the use of the word “bottom” during recent earnings calls. This seemingly simple observation carries significant weight, suggesting that companies believe the worst is behind them and a recovery is on the horizon.

Historically, according to BofA’s analysis, a surge in “bottom” mentions has coincided with an inflection point in earnings per share (EPS). Companies appear to have largely worked through their excess inventory, a key factor that has been weighing on manufacturing activity. As inventory levels stabilize, we can expect a gradual shift towards rebuilding stock, potentially signaling a turning point for the sector.

The outcome of the presidential election has undoubtedly added another layer of uncertainty to the economic outlook. Many companies have expressed a sense of caution and hesitation, delaying major investment decisions until the political landscape becomes clearer.

However, BofA’s analysts already believe that the election itself, regardless of the outcome, will act as a “clearing event.”

Historically, investment activity tends to pick up after elections as businesses gain more clarity about the policy direction of the country. With the election settled, companies may be more inclined to unleash capital expenditures (capex), investing in growth and expansion.

This pent-up demand for investment could provide a significant boost to the economy, particularly the manufacturing sector.

The confluence of several factors — a potential bottoming in manufacturing, increased capex post-election, and a supportive Federal Reserve — could set the stage for a broad-based stock market rally. Even small-cap stocks, which have underperformed in recent years, stand to benefit from this renewed economic momentum.

While challenges persist, the recent surge in “bottom” mentions in earnings calls offers a glimmer of hope. If these signals prove accurate, the US economy may be on the verge of a significant turnaround, paving the way for a brighter future for investors.

A Deeper Dive

To fully appreciate the potential significance of this “bottoming” signal, it’s crucial to go deeper into the data. BofA’s analysis goes beyond simply counting mentions of the word “bottom.” They have meticulously analyzed the context in which the word is used, focusing on instances where it signals a belief in a trough or inflection point in business activity.

Furthermore, their research incorporates other key indicators, such as inventory levels, capacity utilization rates, and new orders data. These indicators, when combined with the “bottom” mentions, provide a more comprehensive picture of the manufacturing sector’s health.

While the signs are encouraging, it’s important to acknowledge that the road to recovery may not be smooth. Several factors could still derail the anticipated rebound, including:

• Geopolitical risks: Rising tensions in various parts of the world could disrupt supply chains and dampen global economic growth.
• Inflation persistence: While inflation has shown signs of moderating, it remains elevated. A resurgence in inflationary pressures could force the Federal Reserve to resume its hawkish stance, potentially hindering economic growth.
• Consumer sentiment: Despite the current strength in consumer spending, a decline in consumer confidence could weigh on economic activity.

Navigating these uncertainties will require careful monitoring of economic data and a flexible investment approach.

The US economy stands at a crossroads. While the services sector continues to shine, the manufacturing sector has been struggling. However, recent earnings calls suggest that the tide may be turning. The increased frequency of “bottom” mentions, coupled with other positive indicators, points to a potential recovery in manufacturing.

This, combined with the potential for increased capex post-election and a supportive Fed, could fuel a broad-based market rally. While challenges remain, the signs are encouraging. Investors who can navigate the uncertainties and identify the opportunities may be well-positioned to reap the rewards of this potential economic turnaround.