ISM Report: Good News

Includes: GT, MBLX, SEH
by: Zacks Investment Research

By Dirk van Dijk

The Institute for Supply Management’s (ISM) manufacturing survey rose to a reading of 59.6 from 56.5 in January, an increase of 3.1 points and above the 57.0 reading that was expected. Any reading over 50 indicates that the manufacturing economy is expanding, so this is a very strong reading, indicating that the manufacturing economy is not only expanding but doing so at an accelerating rate relative to February.

And it is at the highest level so far in this economic cycle. It is also a huge improvement over the rates we were seeing a year ago.

The ISM is a good coincident indicator of the economy, plunging during recessions but then recovering quickly as the recession comes to an end. While the ISM index did not set a new post-war record-low in this recession the way that several other economic indicators did, it still got down to very scary levels, hitting 32.5 in December of 2008. In addition to the overall ISM index, the history of three most important components are shown (production, new orders and employment).

The overall ISM index is composed of 10 sub-indexes. Nine of those indexes are above the magic 50 dividing line. Relative to February, two of the indexes dropped while the other eight sub-indexes all rose.

Beneath the Headline

The most important gauge of the current state of the economy in the report is the production index, which rose 2.7 points, but that did not make up for the 7.8 point plunge in February. If the production index tells where we are, the new orders index helps tell where we are going. The story was very much the same, with a rise of 2.0 points to 61.5, but still below the January level of 65.9. That is still a very strong reading.

Of particular interest right now is the employment index. This is the fourth straight month it has been above 50, meaning that we should be seeing a pick up in manufacturing jobs, but it was the only one of the sub-indexes to drop relative to last month. However that has yet to show up in the BLS statistics, and directly contradicts the ADP data we got yesterday, which showed weakness in the goods-producing sector and strength in the service sector.

To be sure, goods-producing includes construction as well as manufacturing, and most of the weakness was probably in construction. We will see on tomorrow if there was an impact on March. Counter-intuitively, with the new order index higher than the production index (61.5 vs. 61.1), the backlog of orders sub-index fell 3.0 points but it is still at a very healthy 58.0.

The only sub-index that are below the 50 level was customers inventories, with a reading of 39.0, but that was up 2.0 points from last month. If I had to pick a sub-index to be in negative territory to be below 50, it would be this one, since having firms think that their customers inventories are too low indicates stored-up demand. Their perceptions of their own inventories moved into positive territory for the first time in this cycle, with a massive 8.0 point jump to 55.3.

Inventories were the big story in the fourth quarter GDP, accounting for about 2/3 of all the 5.6% growth. However that was due to firms shrinking their inventories at a much slower rate than they had in the third quarter, not from actual restocking of their shelves. This jump in the inventory index means that manufacturing firms are actually starting to replenish their inventories.

In other words, inventories could still be a powerful force to the positive in the first quarter GDP growth numbers. The index for net export orders rose 5.0 points to 61.5, well above the 1.0 rise reported on increased imports to a level of 57.0, which could indicate some improvement in the trade deficit going forward.

In Summary

Overall this was a very encouraging report. It shows that the manufacturing side of the economy is clearly on the mend, and the market should like these numbers. The overall index, the PMI, has been above the magic 50 mark now for 8 straight months, or since August. That is probably around the time that when they get around to it, that the NBER will officially declare that the recession ended.

The March reading is the highest since July 2004, and since 1968 the overall PMI index has been above this level in only 54 months, or 10.6% of the time. Clear evidence of an economy on the mend, at least on the manufacturing side, although manufacturing is a relatively small part of the overall economy.

The non-manufacturing index does not have as long a history as the manufacturing index, but covers a much bigger part of the economy. It is due out next week. In recent months it has also been above the 50 mark, but much lower than the manufacturing numbers.

For each of the sub-indexes, the ISM lists the industries that are doing well and the ones that are not doing so well. In reading over the report, one industry consistently shows up as being weak: Plastic and Rubber products. That is bad news for companies like Goodyear Tire (NYSE:GT), Metabolix (NASDAQ:MBLX) and Spartech (NYSE:SEH). Incidentally, the Rubber and Plastics industries are among the very worst of the 255 industries we track on the basis of the Zacks Rank.

Conversely, the Apparel industry was consistently listed as among the strongest in the various sub-indexes. This means that things are looking up for the likes of Perry Ellis (NASDAQ:PERY) and Phillips Van Heusen (NYSE:PVH).