The Institute for Supply Management’s (ISM) manufacturing index dropped to 50.6 in July from 50.9 in June. While the number is down, and the level is at best mediocre, it represents a major positive surprise — the consensus had been looking for the index to fall to just 48.5.
In other words, the manufacturing economy is still expanding, but just barely. Still, if one steps back a bit, the decline in the overall index has been stunning. Back in February it was at 61.4, the highest level since the early 1980’s.
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 25 straight months.
Manufacturing had been one of the stars of the recovery, but it is clearly fading. We were above 60 for four straight months earlier in the year, an extremely high level, but now we are stalled. Not moving backward into recession, but we have no forward momentum either. In fact, the April reading had been matched or exceeded in only 89 months since the start of 1948, or 11.7% of the time.
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 1961.
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.
The overall index is made up of ten sub-indexes. Six of the indexes improved while four showed deterioration over last month (one of those that was down was for prices, so that really isn’t bad news). Six are above the magic 50 level.
Sub-Indexes in Detail
The sub-indexes are as interesting as the overall index. When one digs below the headline number, this is still a weak report.
Production
In terms of the current state of the economy, the most important of these is the production index. It fell 3.7 points to 48.6, it was as high as 63.8 in April. The decrease is bad news and the absolute level is anemic.
The production index fell below the magic 50 level after being above it for 26 straight months. That run started in June 2009, the “official” end of the Great Recession. Seven industries reported an increase in production while seven saw production fall in August.
Backlog of Orders
However, the index with the biggest impact on the very short term is the backlog of orders. It improved from last month, but is still weak. The order backlog sub-index rose 1.0 points, but only to 46.0. That is the third month in a row it has been below the 50 mark. It was at 61.0 in April.
The order backlog sub-index has been extremely erratic of late. Five industries reported an increase in August, while six reported declines. This points to more short-term softness in the manufacturing sector.
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 told a similar story. It increase by 0.4 points but to just 49.6. This is the second month in a row below the magic 50 level. The last time it was below 50 was in June of 2009, the month the Great Recession officially ended.
This is not a good omen for the next few months. Back in April, the new orders index was at 61.7. The current level of 49.6 indicates that new orders are falling, but not plunging. Seven industries reported higher new orders while seven reported a decline in new orders.
Employment
With unemployment at 9.1% in July, and expected to remain there or even tick up a bit when the employment report comes out tomorrow, the employment sub-index is of particular interest. The employment index fell to 51.8 from 53.5 lat month. It was as high as 59.9 in June. The employment sub-index has been above 50 for a 23 straight months now.
Eight industries reported an increase in employment while six reported a decline. I would point out that the employment sub-index has been pointing to an expansion in factory employment for almost two years now, 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. Unfortunately the FRED database has not yet been updated with this month’s data (should be there by the afternoon).
Of the four key sub-indexes, all were either falling or below the magic-50 mark. Hard to get excited about it. On the other hand, given the behavior of some of the regional “mini ISM’s,” this is not the disaster that it could have been.
Prices Paid
The prices paid index fell 3.5 points — its fourth straight month of sharp declines. It is still well above the 50 mark, though. This is a very clear indication that inflation is not around the corner, and helps explain why the Fed is not going to do a QE3. However, its rapid decline, coupled with other weak data, might help tip the scales in favor of more action by the Fed. It was at 85.5 as recently as April.
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. That argument is rapidly losing validity as the sub-index crashes back down to Earth.
The general rule on the sub-indexes is that the higher they are the better, but the level it was at a few months ago was 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, but we sure are not going to get it on the fiscal front. The level is still on the high side, even the declines.
A Glimpse at Foreign Trade
The ISM index also gives a bit of a glimpse into the foreign trade situation. There the indication is not that good. The index tracking new export orders fell 3.5 points to 50.5 while the index tracking imports rose 2.0 points to 55.5.
Keep in mind that it is net exports, not just raw exports that are important to economic growth. However, the import figure refers to imports of materials or components that domestic manufacturers use, not to finished goods.
Net exports were a very small help to GDP growth in the second quarter, adding 0.09 points to growth. Prior to the dramatic revisions we got in the initial second quarter GDP report, we had thought that net exports were a small positive contributor to growth in the first quarter, but now it looks like they were a 0.34 point drag on growth. We are going to need a lot of help from net exports if we are going to have solid GDP growth in the third quarter. These numbers are a small indication that that help is not likely to arrive.
Mediocre Report…but We Expected Worse
In an absolute sense, this was at best a mediocre report. However, mediocre when the expectation was for a disaster is very good news. Sort of like Irene only hitting NY as a borderline Category-1 tropical storm, instead of hitting as a Category 2. Bad news, but not as bad as it could have been.
While the index has a very long history, its accuracy in forecasting economic growth seems to be breaking down significantly. The readings in the first four months of the year were consistent with an economic boom in the making, yet after the revisions, the economy grew slower than population in the first half.
This month and last month taken together point to a more plodding recovery. Let’s hope that the index has simply broken down as an economic indicator, not that it has suddenly become biased to the upside. The current level of 50.6 in the overall index is near stall speed, and at best seems 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.
Two of the four sub-indexes that I consider to be most important fell, and three are below the magic 50 mark. The Employment index is still above 50, but not by very much. The table below is from the ISM report (from this source) and provides the summary information.
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