Recession Probability With ISM Numbers In Context

 |  Includes: KBE
by: Carlos X. Alexandre

Immediately after the Institute for Supply Management’s PMI number was published there was a sigh of relief, and I saw a cyber parade celebrating the fact that a recession is not in the cards. Don’t take me wrong. I’ll be the first to wear a cheerleader outfit when economic winds change direction.

The ISM report includes a few comments that highlight the sentiment in the various industries, and despite some encouraging words, they’re hardly inspiring.

  • "Earlier chemical price increases are beginning to soften." (Chemical Products)
  • "Business is soft, confidence is down, and we are cutting inventory and expenses." (Machinery)
  • "Exports continue to be strong — domestic weak." (Computer & Electronic Products)
  • "Domestic sales are showing small improvements. International sales are showing larger improvements." (Fabricated Metal Products)
  • "Demand remains constant and strong." (Paper Products)
  • "Current headwinds in the national and international economic environment have increased uncertainty, and are affecting our customers' willingness to commit to high-dollar equipment purchases." (Transportation Equipment)
  • "We continue to post solid numbers, but the situation seems tenuous." (Plastics & Rubber Products)
  • "Automotive business (represents 52 percent of our sales portfolio) continues to be strong. Core business has pulled back slightly." (Apparel, Leather & Allied Products)
  • "Sales continue to be sluggish." (Furniture & Related Products)

The PMI has been in decline since February. The fact that the number is not in negative territory is no consolation, and it falls short of a good reason to pop the champagne. What else has been in decline since February? The KBW Bank index (KBE), showing a year to date decline of 25%. Coincidence? Maybe, but I like to keep an open mind, and banking is always the canary in the coal mine.

First, the components “New Orders” and “Backlog of Orders,” representative of the future, are in negative territory – 49.6 and 46 respectively – and have deteriorated over the last two to three months. The last time “New Orders” contracted was in June 2009, according to the ISM. Not the end of the world, but not the beginning either.

But looking at the “Prices Paid” component, the rise in costs is apparent into April 2011, as commodities shot through the roof. Meanwhile, the ISM number was stating that the higher prices were not conducive to a healthy business environment, and subsequently prices dropped by a significant 30 points, from a high of 85.5 in April to a low of 55.5 in the latest reading. The implication here also relates to inflation and purchase power, and I’m certain that both themes are pretty weak despite the infusion of money into the system.

Thus whether a recession will occur – and we can have one with only two quarters of -0.01% growth – is truly not the problem, and we can debate the issue until the cows come home. The fact remains that weakness is extremely visible, and even with a technical non-stop expansion – continuing growth of 0.01% will work – the economic landscape and, by extension, the stock market environment will remain tenuous at best.

Certainly one can take the ISM numbers in isolation, and hope that the index will turn around. But when considering other factors, such as consumer confidence, currency issues, global sociopolitical instability, and the refusal by bureaucrats to confront the problems head-on, the forecasting becomes a little harder and murkier.

So what’s the probability of another recession? I have never been able to calculate the odds, and the answer is “Yes.”

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.