Disappointing Manufacturing Survey Suggests Weak Growth

by: Bondsquawk, CFA

By Rom Badilla

U.S. manufacturing activity continues to languish in a weakened state signaling less robust growth for the economy, according to data released on Tuesday. The Institute for Supply Management released the results of its survey of over 300 manufacturing companies Tuesday which shows a contraction in activity. The ISM Manufacturing Index for August fell to a reading of 49.6 which is slightly lower by 0.2 from the previous month. While the index barely moved from July, economists were expecting a rebound as evident by the median forecasts by economists of 50.0. The August data is the third straight soft print since May where the index stood at 53.5.

ISM Manufacturing (Green Line) & Recessions (Grey Area)

The components of Tuesday's release justified the weakness as key sub-indices fell from July. New Orders, which are a gauge of future demand of durable goods, fell 0.9 to 47.1. Like the headline number, this is the third straight month of contraction for New Orders after reaching a recent high of 60.1 in May. This lack of robust demand is flowing through as production activity fell from 51.3 in July to 47.2 which is the post-recession low. In addition, the Employment sub-index edged lower but remains in positive territory as the component fell to 51.6 from 52.0 in the previous month.

While key components were down, some were slightly better. Inventories increased 4.0 from last month to 53.0. Demand for U.S. manufactured goods improved slightly and is less contractionary as the New Export Orders component improved from 47.0 to 46.5.

Apparently, the recent rebound in energy prices and surge in commodities due to the recent drought is playing its way into prices which may place upward pressure on inflation. The Prices Paid component spiked significantly from 39.5 in July to 54.0.

Weaker economic growth usually translates into lower stock prices and falling bond yields and vice-versa. A reading below 50 represents contraction in the manufacturing sector while above this threshold suggests growth. A significant downturn in manufacturing activity usually rolls up into the broader economy since an index reading in the low 40's spells a looming recession. Conversely, a number in the high 50's suggests a robust expansion for the U.S. economy. Obviously, the health of the economy can have a huge impact on both stocks and bonds.

While Tuesday's ISM report does not signal a recession for the U.S. economy, it does show that growth continues to be lackluster and another shock of any sort could push it over the edge. This slower pace of growth should continue until the market sees a reversal which may be signaled in the New Orders component. Given the current backdrop of the European Debt Crisis and the impending Fiscal Cliff, this may take some time as uncertainty looms over the global economy as we roll toward the end of the year.

Until then, the market waits for this Friday's job report for further signs of deterioration in the economic data that may prompt the Federal Reserve to perform another round of stimulus measures which should keep bond yields low for the foreseeable future.

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