ISM April: Downers, But Net Up For Manufacturing

by: Ronald Rutherford

While the Manufacturing ISM Report showed general weakness in the indexes and an overall drop in the PMI, the Non-Manufacturing ISM Report showed a significant drop in the headline NMI index, as well as a dramatic drop in new orders. Mike Shedlock noticed that Manufacturing ISM Prices Paid Hits Another High, Up 22nd Consecutive Month and that Non-Manufacturing ISM Plunges Below Prediction of All 73 Economists, New Orders Collapse, Prices Firm.

Both headline numbers dropped, with the NMI dropping 4.5 and the PMI decreasing 0.8%. The manufacturing was above the consensus, with MarketWatch and Econoday Report both at 59.5 and Econoday stating the consensus range of 58 to 60.5%. So while the NMI stayed on the high side of expectations, the PMI was significantly below the consensus of MarketWatch at 57.8 and Econoday at 57%, with a range of 54.5 to 60%. Whenever the actual is outside of the consensus range, then that is a significant event; either the basis of the analysis is faulty or unexpected events were not considered in making the estimates.

Spin or Happiness Pills?

The non-manufacturing report noted some strong negative index numbers, including a six-point drop in business activities index to 53.7%, a dive in the new orders index by 11.4 to 52.7, the employment index approaching the 50% mark also by dropping 1.8 to 51.9%, and new export orders dropping 5.5 to 53.5%. Thus it is curious as to how Anthony Nieves of the ISM stated the following about the report.

Respondents' comments are mixed about overall business conditions; however, they are mostly positive. Respondents' comments also indicate concern over rising fuel costs, commodity costs and the lingering uncertainty about the economy. (Emphasis added.)

As Shedlock noted above, in the manufacturing sectors, prices paid for inputs are rising and getting much worse. The one bright spot was that the non-manufacturing sectors index dropped 2 points but still maintained above 70 at 70.1%. Manufacturing added a little more fuel to the fire with a 1/2 point increase to the highest level since July 2008 at 85.5%.

Last month, all 18 industries from both reports reported increases in prices. This month is not much better, as all 18 in non-manufacturing and 17 in manufacturing reported higher prices. The lone exception was one industry reporting no change in prices. Also, the percentage of respondents reporting higher prices to those reporting lower prices continues to climb. For non-manufacturing it is at a 57:2 ratio and for manufacturing it is at a 72:1 ratio -- meaning that for every manufacturing respondent that said it was paying lower prices, there were 72 others stating they were paying higher prices. That clearly is an unsustainable path.

Let us look at some of the published comments from respondents that Anthony mentions above.

Non-Manufacturing: # "Fuel prices continue to be challenging and in addition to shipping, are influencing the cost of materials." (Public Administration) # "We are seeing price increases in many areas, and the lead times are stretching out. Our business activities are improving at a moderate rate." (Wholesale Trade) # "Looking forward with reserved caution. Cost of goods by this fall are a big worry." (Accommodation & Food Services) Manufacturing: # "Rapidly rising raw material costs putting extreme pressure on profits." (Food, Beverage & Tobacco Products) # "Plastic resin product prices are climbing so fast that [suppliers] are attempting to increase prices on orders already accepted but not [yet] delivered." (Chemical Products) # "Customers are rebuilding safety stock levels of inventory, and also trying to buy ahead of material price increases." (Plastics & Rubber Products)

This comment should be a red flag in regards to growth of the economy or inflation going forward. While on the one hand this increases aggregate demand and increases production for inputs especially, on the other hand it could be a sign that inflation expectations are unmoored. It certainly is not the time to scream "hyperinflation," but I'm not sure that Paul Krugman can continue to be so sanguine about inflation expectations.

Looking at commodity prices also paints continuing concerns about inflation. No commodities had lower prices in either report. Non-manufacturing had slight reductions in total commodities, rising in price at 38 and commodities with consecutive months at 19. Manufacturing continued going up for both categories, with 39 total commodities reported as rising in prices and 30 having consecutive months -- a rise from 22 in March, up from 21 in February and 15 in January.

Norbert J. Ore of ISM Manufacturing Report also seems to be smoking whatever Nieves was when he wrote the following.

Ore stated, "The past relationship between the PMI and the overall economy indicates that the average PMI for January through April (61 percent) corresponds to a 6.5 percent increase in real gross domestic product (NYSEMKT:GDP). In addition, if the PMI for April (60.4 percent) is annualized, it corresponds to a 6.3 percent increase in real GDP annually."

But the U.S. Commerce Department’s Bureau of Economic Analysis stated that real GDP grew 1.8 percent at an annual rate. If the non-manufacturing sectors were also maintaining above 60% levels like manufacturing, then maybe the above analysis might be closer to the truth.

The Bright Spot: Manufacturing

Even though the important index numbers of new orders, production, and employment showed weakness with a decrease of 1.6, 5.2, and 0.3 percentage points, respectively, the "net" percentage of respondents increased in all three indexes. For new orders, the percentage of respondents stating that it was better was 49 versus 8% saying it was worse, with a net of 41%; the month before saw numbers of 43 "better off" and 10% "worse off," with a net of 33.

That trend has been continuing since November 2010, when the net was 5% (30 to 25). Last month's percentages for production were 43 better and 5 worse for a net of 38. This trend also started in November 2010 with a net of 6, divided between 26 "better" and 20% "worse." Lastly, the employment index trend started in December with a net of 10 and 22 higher and 12% lower. Last month, employment was 34 higher and 5 lower for a net of 29%.

The importance of this is that even if the index contracts some, this might be beneficial in the long run as the economy needs a broad base to absorb all the excess labor currently. Of course, without non-manufacturing this will still be hard for the economy to get back on a productive employment path.

This brings us to one of the most important indexes in the reports (at least for now): Non-manufacturing employment index. As noted already, the index dropped 1.8 to 53.7% and the trend seems to be headed back down below the 50% mark. The nets are improving (March 22-13=9, April 26-11=15) but with lower levels of expansion, this is not likely to be of much benefit in employment numbers.

Below is what the recent trends show since the index lows of December 2009. (Click on charts for clearer images.)

The trend line slope declined almost 11% for last month and over 14% for the past two months. This could be a new downward trend in employment for the non-manufacturing sectors indicating contraction in employment. Let's hope not.

More about the Demise of Manufacturing Myth

With the upcoming Presidential election season starting soon enough, there are bound to be candidates who espouse how to save the manufacturing sectors of the US economy. Trump's China-bashing is one example we have already. Mark J. Perry at Carpe Diem presents some important graphs in some of his recent posts to dispel the fear of the "manufacturing demise." Below is value added by industry over time (Service Sector Inflation Remains Mild).

That just confirms that the manufacturing sector is adding less to the US GDP over time, but he also brings up some important points that the services sectors of the economy has not been creating a vicious cycle of inflation in the economy and are unlikely to in the future. His conclusions are as follows.

I've made some of these same points before. In the inflationary 1970s, almost every measure of prices was increasing: food, energy, core inflation, wages, services, interest rates, etc. We now have a wide mix of inflationary, deflationary and flat inflationary forces, along with decelerating wage increases and low interest rates, and that's not a formula that results in overall inflationary pressures. At least not yet. And since inflation for services has been below 2% for almost two years now, there's not inflationary pressure there.

That seems to be the case for now, but it is doubtful that when every industry in both manufacturing and non-manufacturing are experiencing increases in the commodity inputs, there will be no eventual pass-through price increases, even if wage inflation is low or non-existent for now. (See The "Decline or Demise" of U.S. Farming?)

The US and the world economies have already experienced the demise of agriculture. One way to describe the graph above is that we are past the agricultural society, which took humans around 10,000 years to accomplish. Now we are in the dying days of the industrial society. What develops from now is anyone's guess. It is defined above graphically as a services society, but that is likely to be broken down into specific components like finance, health, education etc.

This last graph most importantly shows that it is not the US lagging in manufacturing production; in fact, we are the leader to the new economies of the future. The US is at the "undiscovered country" and there is no turning back, even if we wanted to. (See "Decline of Manufacturing" is Global Phenomenon: And Yet the World Is Much Better Off Because of It.)

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