Yesterday's update on the ISM Services Index delivered a positive counterpoint in the November estimate vs. the discouraging slide in the ISM Manufacturing Index. One of the indicators is feeding us misleading signals about the business cycle. The manufacturing index is warning, albeit mildly, that the economy is weakening. But the services data begs to differ.
“The consumer is carrying a lot more of the economic momentum into the end of the year, given the cautiousness of business leaders,” says Joel Naroff, president of Naroff Economic Advisors, via Bloomberg. "That bodes well for next year.”
For some recent perspective on the data, the chart below tracks the non-manufacturing (services) composite index (red line) and its manufacturing counterpart (black line). Note that the services composite index only dates to early 2008 and so I've included a related services metric—non-manufacturing business activity index (blue line)—that goes back to 1997. The main point is that the services sector data is trending higher while the manufacturing index has again slipped under 50, a sign that the sector is contracting.
click to enlarge
It's quite possible that the manufacturing's darker message is genuine, in which case the relatively upbeat services trend is wrong and will soon dive south. For the moment, however, I'm inclined to give the services numbers the benefit of the doubt. Here's why. First, a rival purchasing managers index from Markit Economics also reports stronger data for November for the manufacturing sector. As the press release from earlier this week noted: "Manufacturing growth strengthens to five-month high in November."
A broad review of economic and financial indicators beyond purchasing managers indexes also suggests that the economy hasn't yet fallen victim to recession, as tracked by The Capital Spectator Economic Trend Index (CS-ETI), which I'll update soon.
It would be foolish, of course, to conclude that all's well and that the economy is sure to avoid a recession. That's obviously a risk, and for a number of reasons, ranging from the ongoing threat via the unresolved fiscal cliff factor to the general backdrop of slow growth that could deteriorate into outright contraction if another large negative shock strikes. But the numbers overall don't yet send a clear and unambiguous warning that a recession has started. That may be coming and we should be open to the possibility in the current climate. Certainly a number of metrics look wobbly, although it's unclear how much of this is temporary due to distortions from Hurricane Sandy.
History suggests that it'll take at least three or four months, at the earliest, before a high-confidence recession alert is signaled--if a downturn is in fact in progress. If we're moving toward such a turning point in the business cycle, the statistical evidence will begin piling up in the weeks ahead. If so, the ISM Manufacturing Index is a sign of things to come. But for now, it still looks like an outlier. When and if that changes, you'll read about it here.