September 5, 2012

US Manufacturing Index: A Prelude to Recession?

By James Picerno of The Capital Speculator

Manufacturing activity in the U.S. contracted for the third month in a row in August, the Institute for Supply Management reports. That’s a sign that economic growth has been sluggish and is likely to remain so. The ISM Manufacturing Index dipped ever so slightly to 49.6 last month vs. 49.8 in July. Any reading under 50 implies that manufacturing, a key sector of the economy, is contracting. But the below-50 reading is shallow, which suggests that manufacturing is closer to treading water rather than shrinking per se. That’s hardly an encouraging reading. 
But given the ongoing growth elsewhere in the economy (assuming it holds up), it’s not yet clear if the moderately weak readings for this indicator are the last word on what happens next for the broader economy.

What is obvious is that manufacturing has been on the defensive since June, according to the ISM index. But it’s also true that this so-far subtle slump has yet to spill over into the broader economy, based on the numbers published to date.


Consider the economic profile for July, the last month with all the major economic reports in hand. Manufacturing have been weak in July, but it didn’t seem to infect other corners of the economy. From personal income and spending to retail sales to private nonfarm payrolls, July overall appeared to contradict the darkness in the ISM report. Most of the discouraging news for July is limited to a mixed bag of numbers for durable goods orders.
But we can't dismiss the fact that the manufacturing trend remains weak, if only marginally so. That raises the obvious question: Will the data for August prove to be a turning point for the economy? Or are the ISM manufacturing numbers of late misleading us about the darkness on the edge of town?

One reason for reserving judgment that the business cycle’s about to tank: the ISM index is less than infallible as a recession indicator. This data series has been known to slip under 50—sometimes well under 50—without a follow-up economic slump soon after. Then again, the same caveat applies to every other indicator, which is why it’s crucial to monitor a broad set of economic and financial data series and strip away the short-term noise by looking at the trend. On that note, here’s how the numbers through July compare:

091412c.GIF

The table above suggests that July wasn’t a tipping point. But the first entry for August is again telling us to beware. Will this be an outlier once more? Or might the full boat of numbers for August reveal a change in the macro weather? The next installment in search of an answer arrives on Friday, with the release of the August payrolls report via the U.S. Labor Department. The consensus forecast (via Briefing.com) calls for a modest gain of 144,000, down slightly from July’s 172,000 jump.

Predictions are a dime a dozen, of course. But this much you can bank on: Given today’s ISM update, the crowd’s capacity for digesting a negative surprise in the all-important news on the labor market is virtually nil. Stay tuned....

About the Author - James Picerno is a veteran financial journalist since the early 1990s at Bloomberg, Dow Jones, etc. before becoming an independent writer/analyst/consultant in 2008.  James is also the author of Dynamic Asset Allocation (Bloomberg Financial, 2010) and he writes at The Capital Speculator(EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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