The manufacturing sector has been having a tough 2015. Our q4 Outlook survey saw all key indicators tail off, pointing to a marginal contraction in manufacturing output for the year as a whole. The survey also saw one of our most resilient indicators – investment intentions over the next 12 months – turn negative for the first time in over 5 years.
What’s happening with manufacturing investment?
Investment intentions in our latest survey came at -3%, the lowest balance since q1 2010. The sector has been facing some considerable headwinds since H2 2014, and this has been reflected in Official Statistics with three straight quarters of negative output growth in 2015.
Expectations for output and orders over the next three months have also turned negative, indicating that manufacturers expect tough conditions to carry over to q1 2016. An overall deterioration in confidence about demand prospects and the build-up of spare capacity in certain sectors have naturally taken the steam off the manufacturing investment engine.
Global uncertainty weighs on confidence
Uncertainty is the arch enemy of investment and we’ve had a considerable dose of that in the global economy this year. The slowdown in China has generated high levels of uncertainty about the potential depth of the downturn and its consequences for global economic growth.
So far, the impact has been mainly felt through the trade channel, where a slowdown in imports from China has spilled-over throughout the Asia Pacific and elsewhere, leading to expectations for the slowest year of global trade growth since the financial crisis.
For export-intensive sectors like manufacturing this has spelled bad news. Export orders in our survey for the past 3 months have been negative in 4 of the past 6 quarters, while manufacturers have failed to see improvements in demand from any region, with Asia leading the slump. Export demand has not seen much support from the Eurozone this year either and exports for most sectors have seen negative growth as attested by this graph.
Exchange rates movements have not helped, with the sterling appreciating against the euro on average by around 11% compared to the 10 months to November 2014. Diverging central bank policy, with the BoE expected to enter a hiking cycle in 2016 and the ECB on full QE mode, should add further upward pressures to an already overvalued sterling/euro position.
Build up for spare capacity in some sectors
Weakness in export demand has not been the only challenge facing manufacturers this year. For some sectors, like metals, mechanical and electrical equipment, subdued UK orders have also weighed on the demand outlook. Basic metals have been the main drag in the investment balance with the sector seeing a large spike in spare capacity over the second half of the year following closures of steel plants across the UK.
The mechanical and electrical equipment sectors have also seen a considerable build-up of spare capacity in 2015. We have talked a lot about the impact of dried up capital expenditure from the oil & gas industry on the manufacturing supply chain and this has taken its toll on investment intentions for manufacturers in these sectors.
Perhaps surprising is the relative resilience of the mechanical equipment sector which reported a flat balance despite hefty drops in output and orders. This is because manufacturers in engineering sectors will invest counter-cyclically to maintain the productivity of their capital, as well as invest in penetrating new markets to diversify their demand base.
Not all sectors are equal
While the overall investment balance has turned negative, and some sectors have scaled-back capital expenditure in the face of spare capacity, not all sectors are equal. The transport sectors have continued to invest strongly, while the food & drink and chemicals sectors have joined the chorus since q2 2015.
Motor vehicles are the strongest performer, with the sector capitalising on robust consumer demand to anchor investment plans. The food & drinks sector is gradually moving past the supermarket wars and attempts to rationalise supply chains are driving investment in the next 12 months.
Finally, the chemicals and pharmaceuticals sectors are upping their investment plans, with the former exploiting lower input costs from the slump in the oil price to prop up output, while the end of the patent cliff for the latter signals a boost to spending on research and development into new products.
What’s the verdict?
The negative overall balance indicates that the factors described above – global uncertainty, unfavourable exchange rates, and subdued oil & gas related activity – are weighing on manufacturers confidence to invest in 2016. Still significant sectoral divergence underpins this verdict, with manufacturers in the transport, food & drink and chemicals sectors expected to continue to invest strongly.
Finally, the negative investment balance in our survey does not mean that manufacturers – even in struggling sectors – will stop investing (with capital expenditure likely to go into productivity improvements), but rather that large investments in extra capacity will be harder to find in 2016.
 Our results are reported in balances which show the number of companies responding positively minus companies giving negative responses