Tuesday, November 3, 2009

ISM Manufacturing Continues to Signal Economic Healing

Yesterday, the Institute for Supply Management’s manufacturing survey, an important growth barometer that we monitor, exceeded expectations (55.7 versus analyst estimates of 53). The Institute was founded in 1915, and is a non-profit trade group with a membership base of more than 40,000 supply management professionals and associations. On a monthly basis it releases separate surveys that measure activity in both the manufacturing and service sectors of the economy. Yesterday’s manufacturing report was constructed by surveying more than 300 firms on different aspects of manufacturing conditions (see table below for the composite (PMI) and its underlying components). Readings above 50 represent expansion and readings below 50 indicate contraction. Some might question why investors follow the survey due to the shrinking percentage of GDP that is derived from manufacturing, but we feel that manufacturing still captures the ebb and flow of the business cycle, and therefore is well worth watching.

What the survey does well is capture the directional movement within manufacturing, what it doesn’t do well is measure the magnitude of the growth or contraction. For example, 50 and above implies growth, but tells you nothing about how robust that growth might be. Some of the individual components of the report were encouraging, particularly employment and production, which had robust gains for the month. The bears may take solace in the weaker new orders component, which could be spun as a harbinger of what will occur as Cash for Clunkers and other stimulus programs expire. At Pinnacle, we don’t put too much emphasis on any one data point, as there is a lot of noise that can occur. However the trend of the data is very important. The latest data point is the third in a row above 50, which seems to confirm that the strong leading indicators we have written about previously correctly anticipated future growth.

Currently, the market appears to be in the middle of a long overdue correction where good data is being brushed over. That’s not all that surprising given recent overbought conditions, and it’s possible that negativity may intensify before this market adjustment is complete. Right now seems to be a time for investors to tune out the headline noise, and focus on the overall weight of the evidence coming out of the data we are following. There’s no guarantee how the data will unfold going forward and we will continue to remain flexible in our forecast, but the ISM data seems to reinforce the idea that the economy is in the midst of healing after a particularly nasty down cycle. If that’s true, than the cyclical bull market should have room for further upside after we work through the current rough patch.