Monthly ISM Indexes: A Canary For Recessions

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Take Heed the ISM Monthly Data

Every month reams of economic data come out that traders and investors can use to trade or make a case for a short or long term investment. One of the most useful and revealing for an intermediate to long term perspective is the Institute of Supply Managers Composite Index. These surveys come in both Non-Manufacturing Sectors and Manufacturing Industry Sectors surveys.

The ISM Manufacturing Index (from

The Institute for Supply Management surveys more than 300 manufacturing firms on employment, production, new orders, supplier deliveries, and inventories. A composite diffusion index of national manufacturing conditions is constructed, where readings above (below) 50 percent indicate an expanding (contracting) factory sector. Export orders, import orders, backlog orders and prices paid for raw and unfinished materials are also measured, but these are not included in the overall index.

The ISM Non-Manufacturing Index (from

The non-manufacturing ISM surveys more than 375 firms from numerous sectors across the United States, including agriculture, mining, construction, transportation, communications, wholesale trade and retail trade. The non-manufacturing composite index has four equally weighted components: business activity (closely related to a production index), new orders, employment, and supplier deliveries (also known as vendor performance). The first three components are seasonally adjusted but the supplier deliveries index does not have statistically significant seasonality and is not adjusted. For the composite index, a reading above 50 percent indicates that the non-manufacturing economy is generally expanding; below 50 percent indicates that it is generally declining. The supplier deliveries component index requires extra explanation. A reading above 50 percent indicates slower deliveries and below 50 percent indicates faster deliveries. However, slower deliveries are a plus for the economy-indicating demand is up and vendors are not able to fill orders as quickly.

As explained above to summarize; when these Indexes are above 50 that signals a positive business climate that is expanding, which usually expresses a very bullish climate and fundamental underpinning for the stock market. Conversely, when the Indexes fall below 50, that signals an economy clearly slowing, struggling, and contracting. These below 50 ISM readings are very bearish. When these Indexes - which are made from surveys from many business insiders and leaders, are below 50 that plainly suggests things are diving off a cliff and contracting. In this climate, there is often not much of a bullish case that can be made for being overweight equities.

You can infer some very obvious and blunt Buy and Sell signals from looking at the following graphs.

All data is from the Federal Reserve.

Graph for ISM Manufacturing PMI Composite Index and S&P 500. 1990 to Present. Shaded portions are Recessions.

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Here is the ISM Data for NON-Manufacturing Sectors and S&P 500. 1999 to Present. Shaded portions are Recessions.

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There is also more granular data available for these ISM surveys. One very useful one is the New Orders Index. 1990 to Present. Shaded portions are Recessions.

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More recently we can examine more closely the two recent recessions and what these survey Indexes were spelling out for the economy and investors. Here are some graphs from 1998 to present. This time period includes the tech bubble Recession and our latest "Great Recession."

ISM Manufacturing PMI Composite Index, ISM New Orders Index and S&P 500. 1998 to Present. Shaded portions are Recessions.

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Notice the prescient ISM Index levels that presages future weakness for the S&P 500 (NYSEARCA:SPY). Often these Indexes clearly provided a substantial warning time with below 50 readings before the recession realizations' eventually reflected in the equity market. Other times the below 50 readings were coincident. Either way the stock market eventually deteriorated.

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