The Institute for Supply Management’s (ISM) manufacturing index fell to 50.8 in October from 51.6 in September. It came in well below the consensus, which was looking for the index to rise to 52.1. This is a “magic 50” index, so any reading over 50 means that the manufacturing economy is still expanding. So this report indicates an even slower rate of expansion than last month, but it is still registering growth.
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. The report is not indicating that we are in a new recession, just a continuation of the very anemic pseudo-recovery.
However, the relationship between the ISM readings and GDP growth does seem to be breaking down. The year-to-date average for the ISM of 55.7 historically correlates to GDP growth of 4.6%. In fact so far this year we have only grown at 1.4%, and the best growth came in the third quarter when we were just slightly in expansionary mode according to the index, and the worst was in the first quarter, when the index was at levels consistent with a historic economic boom.
The overall index has now been above the magic 50 mark for 27 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 little forward momentum either.
When one digs below the headline number, this is better than the headline would suggest, but still a fairly weak report. In terms of the current state of the economy, the most important of these is the production index. It fell 1.1 points to 50.1, still above the 50 mark, but only by the skin of its teeth.
The index with the biggest impact on the very short term is the backlog of orders. It was below 50 for the fifth straight month, but it was also the biggest gainer of the sub-indexes rising 6.0 points to 47.5. It was at 61.0 back in April.
In terms of economic activity, the production index is trailing, since it is about what the firms were actually producing in October. The backlog of orders gives a better indication of where things are going in the near future, or what is happening right now.
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 was the only other sub-index to increase, rising 2.8 points to 52.8. That is the first time we have seen the new order index above the 50 mark after four months of indicating contraction. This is a good omen for the next few months.
The employment index fell slightly to 53.5 from 53.8 last month. It was as high as 59.9 in June. The employment sub-index has been above 50 for a 25 straight months now. Obviously it would be better to see this sub-index rise than fall, but it is nice to see it still comfortably in expansion mode.
I would point out that the employment sub-index has been pointing to an expansion in factory employment for over 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.
The prices paid index plunged 15.0 points, dropping to 41.0, the lowest of all the sub-indexes. This is a dramatic turnaround from earlier in the year. That dramatic fall is move evidence that whatever inflation we have in the system is transitory and is going away.
Most of the prices paid in this index though tend to be commodities, not final goods. With the sharp drop in commodity prices in September, perhaps the weakness should not come as a surprise. Until now, the high prices paid sub-index was important ammunition for those who are critical of Federal Reserve’s quantitative easing program. Now that ammo will be in the hands of those who favor easing.
The ISM index also gives a bit of a glimpse into the foreign trade situation. There the indication is bad news, although not particularly for the U.S. trade deficit, but for the overall pace of world trade. The index tracking new export orders fell 3.5 points to 50.0, while the index tracking imports fell 5.0 points to 49.5.
The fact that the export index is both above the import index, and that it fell less should be seen as good news from the trade deficit point of view. On the other hand it indicates a slowing on both sides.
This was, at best, a mediocre report. Yes it still indicates and expansion, but one that is running even slower than last month, and that was too slow. It was also substantially weaker than expected. While the index has a very long history, its accuracy in forecasting economic growth seems to be breaking down significantly.
The current level of 50.8 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 but three are above the magic-50 mark. The employment index is still above 50, but not by very much.
The table below is from the ISM report and provides the summary information.
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