The Institute for Supply Management’s (ISM) manufacturing index rose to 55.3 in June from 53.5 in May. This was a big positive surprise as the consensus had been looking for the index to fall 51.1.
Based on historical experience, the June reading is consistent with GDP growth of 4.5%. Then again, perhaps there has been a change in the relationship, since the average level so far this year is consistent with 5.7% growth, and we only grew at a 1.9% rate in the first quarter, and most indications (aside from the ISM number) are that the second quarter rate will be near the first quarter level, if not slightly below it. Manufacturing has been diminishing in importance to the overall economy for decades now.
This is a “magic 50 index” where any reading over 50 indicates that the manufacturing side of the economy is expanding and any reading under 50 indicates a contraction in manufacturing. The overall index has now been above the magic 50 mark for 23 straight months.
The key takeaway from this number is that the manufacturing sector is expanding, and is starting to rebound from the sharp slowdown it suffered in May. It is still well below the absolutely fabulous level it was showing earlier this year.
The increase this month only partially makes up for the massive decline last month, but that was coming off a reading is extremely strong by any historical perspective. In fact, it was been matched or exceeded in only 89 months since the start of 1948, or 11.7% of the time, and almost all of those instances are ancient history. Since 1980, the April level been matched or exceeded only 19 times, or 5.1% of the months. The graph shows the history of the overall index since January 1980.
The ISM index has a very long and venerable history; it used to be known as the Purchasing Managers Index, or PMI. However, it is simply a survey of purchasing managers at various firms in different industries, and it does not weight by the size of the firm.
A Look at the Sub-Indexes
The overall index is made up of ten sub-indexes. Six of the indexes improved while four showed deterioration over last month (well, one of those was down, but it was for prices, so that really isn’t bad news). On the other hand, eight are above the "magic 50" level; the measures tracking customers inventories and order backlog were the only exceptions.
Production
The sub-indexes are as interesting as the overall index. In terms of the current state of the economy, the most important of these is the production index. It rose 0.5 points to 54.5, but that hardly makes up for last month when it fell 9.8 points.
The increase is good news and the absolute level is still OK. The production index has been in positive territory for 25 straight months now. Ten industries reported an increase in production while three saw production fall in April.
Backlog of Orders
However, the index with the biggest impact on the very short-term is the backlog of orders, and there the picture is also one of deterioration. The order backlog sub-index fell 1.5 points on top of a plunge 10.5 points in May, and is now below the magic 50 level at 49.0.
The order backlog sub-index has been extremely erratic of late. Seven industries reported an increase in June, while eight reported declines. The erratic nature of the sub-index so far this year might be the silver lining here, raising the odds for a big increase next month…but I would not take that to the bank.
New Orders
Looking just a bit further out, as existing orders in the backlog are worked off, they need to be replaced with new orders. The new orders sub-index thus gives us the best view of where things will be in the next few months.
The rebound this month was small, rising just 0.6 points, but at least it moved in the right direction. In May, the new orders index plunged to 51.0 from 61.7. The current level of 51.6 indicates that new orders are growing, but not at a very exciting pace. Much of the decline last month was due to the Japanese disaster, and that impact seems to be fading.
New orders have been on the rise for 24 straight months now. Ten industries reported higher new orders while seven reported a decline in new orders. Manufacturing has been one of the bright spots in this recovery.
Employment
With unemployment at 9.1% in May, and expected to remain there or even tick up a bit when the employment report comes out next Friday, the employment sub-index is of particular interest. The employment index rose to 59.9 from 58.2 in May. The employment sub-index has been above 50 for a 21 straight months now.
Eleven industries reported an increase in employment, while only one reported a decline. I would point out that the employment sub-index has been pointing to an expansion in factory employment for over a year and a half, and so far growth in manufacturing jobs has been pretty weak according to the BLS (then again, growth in manufacturing jobs has been weak for decades, even when the overall economy is doing well). The next graph shows the more recent history (since 1993) of these four key sub-indexes:
Prices Paid
The prices paid index fell 8.5 points, its second-straight month of sharp declines, but remains at the highest overall level, at 68.0, of any of the sub-indexes. This is a very clear indication that deflation is not around the corner, and helps explain why the Fed is not going to do a QE3.
Most of the prices paid in this index though tend to be commodities, not final goods. Still, the high prices paid sub-index is be ammunition for those who are critical of Federal Reserve’s quantitative easing program. The general rule on the sub-indexes is that the higher they are the better, but this sort of level is a bit worrisome, and this is the one decline that I see as welcome news.
Given the rest of the data out there, it seems clear to me that we still need more economic stimulus, both fiscal and monetary. The level is very high, even with this month’s decline; however we were higher than the March or April level on this sub-index as recently as July of 2008.
Foreign Trade
The ISM index also gives a bit of a glimpse into the foreign trade situation. It seems to be indicating a bit of a slowdown in the growth of world trade. The index tracking new export orders fell 1.5 points to 53.5 while the index tracking imports fell 3.5 points to 51.0. The bigger decline in, and lower level of, imports than exports might seem to indicate a bit of an improvement coming in the trade deficit.
However, the import figure refers to imports of materials or components that domestic manufacturers use, not to finished goods. Net exports were a slight help to GDP growth in the first quarter, adding 0.14 points from growth, but that was in sharp contrast to the fourth quarter where an improvement in net exports boosted growth by 3.27 points.
In other words, if the trade situation had remained unchanged from the third quarter, GDP growth would have been slightly negative in the fourth quarter, not +3.1%. We are going to need a lot of help from net exports if we are going to have solid GDP growth in the second quarter.
Up, and Better than Expected
Overall this was a very nice report. It was better than the consensus expectation, and it rose, rather than fell. However it only partially reverses the disaster of a report last month. The readings in March and April were consistent with an economic boom in the making. This month and last month taken together point to a more plodding recovery.
The current level of 55.3 in the overall index is still pretty solid, but not exciting the way the March and April reports were. They seem to point to a continuation of a pseudo-recovery. One where the economy is technically growing, but not enough for anyone, especially the unemployed, to feel it.
Three of the four sub-indexes that I consider to be most important — Production, New Orders and Employment — have risen and are above the magic 50 level. Employment is the only one that is very healthy, while Production and New Orders are just OK. The fourth, Order Backlog, is both down for the month, and showing contraction. It has been extremely erratic so far this year, so that is a bit of a silver lining, but both the decline and the level have to been seen as a dark cloud.
The table below is from the ISM report and provides the summary information.
*Number of months moving in current direction.
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