Wednesday, 1 August 2012

US Manufacturing PMI: Fractional Contraction

Earlier today the Institute for Supply Management published its July Manufacturing Report. Today's headline PMI is showing the second month of contraction after 34 months of expansion. Here is the report summary:
The PMI registered 49.8 percent, an increase of 0.1 percentage point from June's reading of 49.7 percent, indicating contraction in the manufacturing sector for the second consecutive month, following 34 consecutive months of expansion.
The New Orders Index registered 48 percent, an increase of 0.2 percentage point from June and indicating contraction in new orders for the second consecutive month, but at a slightly slower rate. Both the Production Index and the Employment Index remained in growth territory, registering 51.3 percent and 52 percent, respectively. The Prices Index for raw materials registered 39.5 percent, an increase of 2.5 percentage points from the June reading of 37 percent, indicating lower prices on average for the third consecutive month. A growing number of comments from the panel this month reflect a slowdown in their businesses and general concern over increasing economic uncertainty.
I have been reluctant to put very much focus on this index for various reasons, but they are essentially captured in's Big Picture comment on this economic indicator.
This [the ISM Manufacturing Index] is a highly overrated index. It is merely a survey of purchasing managers. It is a diffusion index, which means that it reflects the number of people saying conditions are better compared to the number saying conditions are worse. It does not weight for size of the firm, or for the degree of better/worse. It can therefore underestimate conditions if there is a great deal of strength in a few firms. The data have thus not been either a good forecasting tool or a good read on current conditions during this business cycle. It must be recognized that the index is not hard data of any kind, but simply a survey that provides broad indications of trends.
The first chart below shows the Manufacturing series, which stretches back to 1948. I've highlighted the eleven recessions during this time frame and highlighted the index value the month before the recession starts.

For a diffusion index, the latest reading of 49.8 is slightly contractionary. How does that compare to the months before the start of recessions? Here are the eleven data points for the months before recessions arranged in numeric order with the latest data pointed included (highlighted in red).
42.1, 44.8, 45.7, 47.2, 47.8, 48.5, 49.2, 49.8, 50.5, 50.7, 53.2, 66.2
Seven were lower than the latest data, and four were higher (the recessions that began in 1969, 1973, 1981 and 2007). The two extremes are rather interesting: At the high end is the month before the recession triggered 1973 Oil Embargo. The economy was clearly blindsided. At the low end was the recession following the bust.
But how revealing is today's 0.1 point change from last month? There are 775 monthly data points in this series. The average month-to-month point change is 2.02 points. So today's headline PMI number suggests that manufacturing is, well, treading water.
To reiterate the assessment: "The data have thus not been either a good forecasting tool or a good read on current conditions during this business cycle." The ISM reports nevertheless offer an interesting sidebar to the ongoing economic debate.
Note: I use the FRED USRECP series (Peak through the Period preceding the Trough) to highlight the recessions in the charts above. For example, the NBER dates the last cycle peak as December 2007, the trough as June 2009 and the duration as 18 months. The USRECP series thus flags December 2007 as the start of the recession and May 2009 as the last month of the recession, giving us the 18-month duration. The dot for the last recession in the charts above are thus for November 2007. the "Peak through the Period preceding the Trough" series is the one FRED uses in its monthly charts, as illustrated here.

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