ISM Manufacturing Index Drops 2 Points In April

Summary

• The ISM manufacturing index dropped from 59.3 in March to 57.3 in April.
• Companies are increasingly witnessing higher prices and a tighter labor market.
• Traders are selling some cyclical positions.

In this article, I am going to discuss the number one leading indicator for the US economy: the ISM manufacturing index. This index tells us what we can expect in terms of economic growth over the next 1-3 months. Hence it is called a 'leading' indicator.

Moreover, a value above 50 indicates economic expansion while a value below 50 indicates the exact opposite.

Before I go any further, I highly advise everyone who wants to know more about the validity of this ISM approach to read this article.

ISM Came In Weaker As Expected

The graph below compares two indicators. The first one being my average of regional manufacturing surveys while the other one displays the ISM manufacturing index. I use regional surveys to predict the ISM manufacturing index and to get a better picture of the state of the economy. In my most recent article, I mentioned that a decline towards 57 points is very likely. And that is exactly what happened. The ISM manufacturing index dropped 2 points to 57.3 points versus expectations of 58.3. In other words, growth slowing is a bit worse than expected.

Moreover, it is highly likely that we are getting an economic peak. This is also confirmed by new orders who dropped to 61.2 points but still managed to ignore the fact that regional new orders were indicating a drop towards 58 points.

In other words, what we are dealing with is economic growth at rock solid levels. The only problem is that we are seeing an economic peak. In other words, economic expectations are falling. And this is bad regardless whether we are at record sentiment levels or very low levels. Simply because recent moves/sentiment changes have been priced in.

The summary below shows that key indicators are weakening across the board. Even though it is not at an alarming rate. Employment, production, inventories are all down.

Source: Institute for Supply Management

However, there is one indicator that is not down. Prices are further accelerating to almost 80 points in April. Current price expectations are at their highest level since early 2011.

Source: Author's Spreadsheets (Raw Data: ISM)

The two reasons are higher commodity prices given that oil almost hit $70 per barrel and the import tariffs. This month's comments from industry insiders perfectly explain this. Overall, the comments suggest strong growth and massive pressure from prices and a tightening labor market. All of this makes sense given the above-average reading of the ISM manufacturing index.

Source: Institute for Supply Management

Below, you see the ISM employment index. Just like the composite index we see a decline in April. However, employment is still at rock solid levels which means that total non-farm payrolls could have another strong gain in April - current expectations are at 198K new jobs.

Source: Author's Spreadsheets (Raw Data: ISM)

What's Next?

When writing these articles, It is always extremely important to make clear what I expect going forward. First of all, the current growth peak is a fact. Moreover, the further decline of sentiment is an indication that growth slowing is happening.

Even though growth is still at above-average levels, we see that traders are repositioning themselves according to a weaker outlook. Two of my favorite indicators to track investor sentiment are declining as you can see below. The red line displays the ratio between industrials and the S&P 500 while the blue line displays the ratio between basic materials and utilities.

Going forward we can expect some pressure on industrial production, new durable goods orders and other coincident indicators.

However, and this is where it gets important, I am not calling for a recession nor do I expect the stock market to crash. We are just seeing the first signs of growth slowing. Yes, this could end ugly, but we could also see extended growth at these levels which would then again support the stock market.

Personally, I cut some exposure but did not turn bearish.

Stay tuned!

Thank you for reading my article. Please let me know what you think of my thesis. Your input is highly appreciated!

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.