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The lagging manufacturing sector may be about to rebound, according to a reliable indicator

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Key Points
  • Chip stocks may be pointing to a rebound in the broader manufacturing sector, which has been in contraction since the summer, according to key data.
  • There appears to be a correlation between the ISM manufacturing index and the performance of the SOX Philadelphia Semiconductor Index, so ISM may be getting ready to follow the SOX higher.
  • A rebound in manufacturing is likely because the slowdown has not spread to other parts of the economy, according to Natixis economist Joseph LaVorgna.
An employee inspects semiconductor chips.
Dario Pignatelli | Bloomberg | Getty Images

Chip stocks may be pointing the way to a rebound in the manufacturing economy.

Manufacturing activity has been contracting since the summer, according to the widely watched ISM manufacturing index, but that may be about to change.

Natixis economist Joseph LaVorgna said the performance of semiconductor stocks has diverged sharply from the ISM recently, with the PHLX Semiconductor sector index (SOX) springing higher, while the ISM continues to point lower. Typically the two move in tandem, and the divergence is unusual.

"There's a massive gap between the two. ... It suggests there should be some upside in the ISM," he said. Chip manufacturers are economically sensitive, and they can improve and decline ahead of other sectors.

Source: Natixis

Bank of America Merrill Lynch strategists also pointed to the rising SOX index as a signal that manufacturing may be on the cusp of a rebound. "We are bullish macro," they wrote. They said the surge in the SOX implies the ISM manufacturing index should be at a level greater than 55 over the next three months.

"These manufacturing cycles tend to be self-correcting. I'm guessing the sector self-corrects. The rest of the economy looks OK," said LaVorgna, chief economist of the Americas. "Unless it leads to layoffs, which it hasn't, it's going to burn itself out."

ISM manufacturing for October was 48.9, in contraction for a third month but improved over the 48.3 in September. Anything below 50 signals contraction. The November report is expected Dec. 2.

LaVorgna said he's become convinced that the malaise in manufacturing will be short-lived since it is showing no sign of spreading into other parts of the economy. Manufacturing is also cyclical, and periods of contraction are normal during long business cycles, he said.

Source: Natixis