Another Sign The Industrial Recession Is Bottoming: ISM Inventories Vs. New Orders

by: Hale Stewart

By New Deal Democrat

The overall most important economic question this year is whether the industrial recession caused mainly by the strong US$ will end, and if so, when?

I have suggested that there are signs of a bottoming out in the spot price of the trade weighted US$ and industrial commodity prices. Yesterday we got a third indication in the ISM manufacturing report.

As an initial matter, the inventories component of the ISM index is an excellent coincident indicator for YoY real GDP. Here are three graphs covering the last 70 years to show that:

Besides being a more timely sign of a Quarter's GDP, as you hopefully can see in those graphs, the ISM inventories index also bottoms out sometime between the middle of a recession to a few months after its end. Most often the bottom is within one month of the bottom of the recession.

The inventory index in 2015 made a bottom in October. Usually - but not always - there is no lower bottom.

Just as important is the relationship between the ISM new orders index and the inventory index. As you can see in the below graphs covering the last 70 years, typically late in a recession the new orders index spikes higher, into expansion, while the inventories index is still contracting, near the index's ultimate low:

The same pattern holds true for downturns that do not sink all the way into recession. Here is 1966:

and here is 1985-86, which was also associated with a steep decline in gas prices:

Now here is a close-up on the last few years:

In January the ISM new orders index spiked higher, into expansion, while the inventories index remained near its low, showing continued contraction in inventories.

Typically both new orders and inventories make V-shaped bottoms. While it is only one month's data, January is most consistent with new orders exiting the industrial recession, with inventories continuing to contract, but perhaps less intensely, in the next few months. In short, more evidence of an approaching bottom to the industrial recession.

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