By Dirk van Dijk
The Institute for Supply Management’s (ISM) manufacturing index fell to 56.6 in November from 56.9 in October. In September it was at 54.4. This was a minor positive surprise, as the consensus had been looking for the index to fall to 56.5.
This is a “magic 50 index,” where any reading over 50 indicates that the manufacturing side of the economy is expanding and any reading under 50 indicates a contraction in manufacturing. The overall index has now been above the magic 50 mark for 16 straight months.
The key takeaway from this number is that the manufacturing sector is still expanding, but at a slower rate than in October. The overall index topped out in April at 60.4.
The graph below shows the history of the overall index for the last 30 years. It shows that while declining in recent months, it still remains at what has historically been a very solid rate. Over that period, the average has been 51.2, and the December 2008 low was 32.5.
The ISM index has a very long and venerable history: it used to be known as the Purchasing Managers Index, or PMI. The overall index is made up of ten sub-indexes. Overall, four of the indexes showed improvement over last month and five showed deterioration, with one unchanged. Eight are above the magic 50 level, while the index tracking purchasing managers views of their customers inventories, and the backlog of orders were below the 50 level.
Results by Sub-Index
The sub-indexes are as interesting as the overall index. When one digs below the headline number, this is a much weaker report than it appears. In terms of the current state of the economy, the most important of these is the production index. It fell 7.7 points to 55.0, which is still a pretty good reading, but the sharp decline is disconcerting.
The production index has been in positive territory for 18 straight months now. Six industries reported an increase in production while seven saw production fall in November.
However, the index with the biggest impact on the very short term is the backlog of orders, and there the picture is much weaker. The order backlog sub-index was unchanged at 46.0, its third straight month below the 50 mark. The weakness in order backlogs is a troubling development. Four industries reported an increase in November, while nine reported declines.
Looking just a bit further out, as existing orders in the backlog are worked off, they need to be replaced with new orders. The new orders sub-index thus gives us the best view of where things will be in the next few months. The new orders index fell to 56.6 from 58.9.
In other words, new orders continue to rise but at a somewhat slower pace than last month. New orders have been on the rise for 17 straight months now. This is still a healthy level of new orders, but we would like to see an acceleration, not a deceleration.
With unemployment at 9.6% in October, and expected to remain there when the employment report comes out next Friday, the employment sub-index is of particular interest. The employment index fell to 57.5 from 57.7 in August. However, the ADP report out this morning showed an increase of just 16,000 manufacturing jobs in November. The employment sub-index has been above 50 for a full year now. Eleven industries reported an increase in employment, while only four reported declines.
The prices-paid index fell 1.5 points, but remains at the highest overall level, at 69.5, of any of the sub-indexes. This would be an indication that deflation is not around the corner, as some of the other price indexes like the CPI have seemed to be indicating.
Most of the prices paid in this index though tend to be commodities, not final goods. Still, the high prices-paid sub-index is ammunition for those who are critical of Federal Reserve’s quantitative easing program. The bond market has clearly been worried about the potential for deflation, as that is the only macro scenario in which the 10-year T-note yields of under 2.9% make any sense.
A Glimpse at Foreign Trade
The ISM index also gives a bit of a glimpse into the foreign trade situation. It seems to be indicating a deterioration in the trade deficit. The index tracking new export orders fell 3.5 points to 57.0 while the index tracking imports rose 1.5 points to 53.0. However, the import figure only refers to imports of materials or components that domestic manufacturers use, not to finished goods.
Still, the figures seem to point to a further deterioration in the trade deficit and net exports. Net exports were a huge drag on GDP growth in the third quarter, subtracting 1.76 points from growth. In other words, if the trade situation had remained unchanged from the second quarter, GDP growth would have been 4.3% in the second quarter, not 2.5%. Thus this sign of further potential weakness in net exports does not bode well for GDP growth in the fourth quarter.
Our Take: Disappointing
Overall this was a disappointing report. Yes, it was slightly better than the consensus expectation, and a 0.3 point decline in the overall index is not the end of the world.
The overall level is still healthy. On the other hand, the deterioration in the key sub-indexes of production, new orders and employment are not welcome developments. The order backlog index needs to climb back above the 50 mark. The table below shows the details of this month’s report.