The market wanted to open higher Monday, but a 10:00 AM stunner forced an about face. ISM's Manufacturing Report on Business showed the sector contracted in June. Surprising as it may seem to Wall Street Greek readers, some market mavens had not even considered the possibility. However, we wrote Europe is Already Hurting the U.S. Economy and Manufacturing Data Show Softening Economy in January, and first began warning of a slowing manufacturing sector in August of 2011. We hope you will get on board so as to not miss our latest forecasts.
Ala Muhammad Ali, ISM's Manufacturing Index shocked the world. The Purchasing Managers Index fell to 49.7%, down from 53.5% in May. It certainly shook up economists, who had forecast the index to slip only to 52.0%, based on Bloomberg's survey. The most negative forecast did not even predict contraction, viewing downside at 51.0% for the index. On the high end, one economist thought the PMI would mark 53.4%. At least none of them had forecast an expansion of manufacturing activity, but who could, given the poor data coming out of regional Fed districts over the past few months. The SPDR S&P 500 (NYSE: SPY) had resurfaced by late afternoon, but the SPDR Dow Jones Industrial Average (NYSE: DIA) was having a harder time getting its head above water. Indeed, major components of the Dow were dazed, with Boeing (NYSE: BA) down near 2%, Caterpillar (NYSE: CAT) cut 1.6%, and Exxon Mobil (NYSE: XOM) and United Technologies reduced by a half point. The Industrial Select Sector SPDR (NYSE: XLI) was hurt 1.3% near the close.
The details of the report were downright dire, with the New Orders Index shredded 12.3 points to 47.8. Order Backlog was likewise reduced 2.5 points to 44.5. It looked near certain that international demand was weighing, with the Exports Index down 6 points to 47.5. The report indicated that comments from the panel ranged, with some purchasing managers expressing continued optimism and others focusing their concern on slowing activity in Europe and China.
One positive aspect was that if exports weigh on manufacturing, it doesn't necessarily kill our service driven domestic economy. Manufacturing only makes up 10% of American economic production. That said, no new layoffs here at home could be absorbed by an already ailing labor market. The employment component lagged as is typical for employment, with the related index down only fractionally to 56.6. Consumer spending and consumer confidence are already showing significant damage, and so we could easily be led into economic recession.
Prices fell sharply for the second straight month, with the Prices Index down 10.5 points to 37.0. This measures the prices paid for raw materials. Commodities reported down in price included: Aluminum; Aluminum Products; Brass Products; Copper; Corn; HDPE; Oils; PET Resin; Plastic Products (2); Polypropylene Resin; Propylene; Soybean Oil; Steel (4); Steel - Carbon Sheet; Steel - Cold Rolled; and Steel - Hot Rolled. That has got to impact the operations of companies like Alcoa (NYSE: AA), BHP Billiton (NYSE: BHP), Rio Tinto (NYSE: RTP), Vale (NYSE: VALE) and Freeport-McMoRan (NYSE: FCX). I would be selling the names now if I held industrial metals and materials producers to begin with.
It's the first time the manufacturing sector has contracted since July of 2009 or roughly three years. The reasons are clear, economic contraction and slowing production from Europe, and also from China now as well. The interconnected global economy is feeling the effects of contraction in the EU, the world's largest economy. It's infecting everything, and so the world woke up today, though it looks to me like stocks are missing the point I'm making as they recover into the close. I hope at least the readers of my column take heed, because this is the best reason you've had yet to believe. You don't have to be shocked with the world when GDP contracts and stocks retrace ground; you can start hedging today.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.