Tuesday, November 02, 2010

Macro View: ISM October, More Structural Rigidity

The last post of the Macro View of the Markets discussed structural rigidity in the context of the ISM manufacturing index. After reading the latest manufacturing and non-manufacturing ISM reports, I find some of the same indicators for structural rigidity. For example, the price indexes continue to be very high, more commodities are not only in short supply but more are rising in prices, supplier deliveries were slower, and in the manufacturing sector customer inventories were too low and backlog of orders is low with manufacturing inventories building up.

On the other hand, the reports showed very positive signs about recovery of the economy. Econoday stated the following about the manufacturing report, "The manufacturing sector surged in October led by a burst in new orders and supported by strong employment gains." (1) and for the non-manufacturing, "This report is very positive, indicating that prior and once again accelerating gains in the manufacturing sector are now spilling into the non-manufacturing sector." (2) Hopefully the last statement is an indication of the creation of a virtuous circle, that is, as the spillover from one sector affects the next sector to expand which then affects another sector until all sectors of the economy are experiencing the "spill over" effects.

Both the manufacturing index {PMI}(3) and non-manufacturing index {NMI}(4) showed continued growth at even a faster pace with PMI increasing 2.6% points to 56.9% and the NMI increasing 1.1% points to 54.3%. The NMI beat the consensus as reported by Econoday and MarketWatch marginally at 53.5% and 54% respectively. The PMI showed the most dramatic move of all with it handily beating the consensus of both sources at 56.9%. MarketWatch consensus even thought the index might drop slightly to 54% while Econoday indicated a minuscule increase of .1% to 54.5%. Most importantly it also blew out the consensus range that Econoday reported as 53.6 to 55.5%. If the consensus is unbiased and not skewed then when an index is outside of its consensus range, then this should be a significant indicator about strength or weakness in the indicator.

Is the Economy Firing on all Cylinders?
One fact that popped out when looking at the comparative numbers in the two reports was that more of the indexes are grouping on the positive side of the 50% dividing line if not also correlating more closely. For example, last November's report showed divergence {one over and one under the 50%} in 6 comparative indexes and the most recent report showed only two. This mostly just reflects the fact that non-manufacturing is catching up with manufacturing with respect to improvement in performance criteria. As shown earlier, the headline indexes {PMI & NMI} are increasing and maintaining levels around the mid-50s. The production/business activity indexes showed substantial gains at 5.6% for NMI and 6.2% for PMI to arrive at 58.4% and 62.7% respectively. New order indexes converged as both sectors increased with PMI doing the catchup work with a gain of 7.8% to 58.9% and NMI increasing 1.8% to 56.7%. Employment for non-manufacturing still maintained its positive stance for the second consecutive month at 50.9%. Unlike non-manufacturing, manufacturing continues to have good employment indexes and the most recent report showed an increase of 1.2% to 57.7%. Lastly, another convergence is happening with regards to the price indexes. Non-manufacturing price index jumped a massive 8.2% to 68.3% while manufacturing increased slightly at 0.5% but was already sky high ending at 71%.

What does it all mean?
The report overall is a good one, but there is plenty of room for concern regarding prices and shortages of commodities. It is worth noticing that 13 industries in both manufacturing and non-manufacturing report higher prices and only one and none reported lower prices respectively. As far as the breakdown in respondents by percentages, 49% reported higher prices and 7% lower in the manufacturing sector and for non-manufacturing it is 32% and 3%. Thus for every firm reporting lower prices, 7 reported higher prices for manufacturing and nearly 11 said it for non-manufacturing. Last month the ratio for manufacturing was over 1 to 11. Definitely those are signs of structural concerns and possible inflation concerns.
To be QE2 or not to be QE2?
But new export orders were still very positive and the overall components of the ISM report were excellent. This then begs the question as to whether the new round of quantitative easing (QE2) is necessary or justified at this time especially given the strong employment reports from the Bureau of Labor Statistics. On the one hand, Bernanke is making a gamble that the economy is not going to heat up in the next 12 to 18 months {as that is the length of time for most monetary measures to take effect}, and the length of time it will take to absorb all the unemployed, underemployed and discouraged workers to become fully employed. The EPI notes that under even the good results from October, this process may take 20 years. (6) They succinctly noted the following:
If the rate of job growth were to continue at October’s rate, the economy would achieve prerecession unemployment rates (5% in December 2007) in roughly 20 years. For the fourth straight month, the unemployment rate held steady at 9.6%.

So far the Fed has been getting the direction of the economy correctly, and I believe that they will continue to make prudential decisions. Just remember that the deficit hawks should be eating humble pie. R.A. from The Economist sums up why much of the criticisms are not substantial and are unfounded (7), while G.I. summarizes why the international criticisms are unjustified (8). Both articles should provide an understanding of why some of the critiques are wrong on QE2.

International Manufacturing Indexes
Maybe there is nothing like the "bond vigilantes" that Paul Krugman talks about, but there still may be gremlins in the form of structural rigidity in the motor we call the US and world economies. In fact the Wall Street Journal thinks that global manufacturing is picking up and gave us the following story (5):
It’s a story that goes something like this: Early in the recovery, manufacturers around the world stepped up production to rebuild inventories that were depleted in the downturn. But they overshot by a bit, lifting inventories above what was necessary, and so had to throttle back a bit to bring inventories back into balance. Now they’ve done that, so manufacturing growth is heating up again.

That story sounds a lot like the case of the US at least. I can not say that the educated economists at J.P. Morgan are wrong about the slowing down of global manufacturing. But hopefully, they are wrong since this recovery is going to only happen with manufacturing leading the way, as it seems was the case in the US.

(1) Econoday Report: ISM Mfg Index November 1, 2010

(2) Econoday Report: ISM Non-Mfg Index November 3, 2010

(3) ISM - Media Release: October 2010 Manufacturing ISM Report On Business®

(4) ISM - Media Release: October 2010 Non-Manufacturing ISM Report On Business®

(5) Global Manufacturing Picking Up - Real Time Economics - WSJ

(6) Job growth improves, but pace leaves full employment 20 years away

(7) America's economy: The QE backlash | The Economist

(8) QE2 and the Fed: It goes to the Fed’s motive | The Economist

Market Watch:
Actual Consensus forecast
ISM Oct. 56.9% 54.0%

ISM services Oct. 54.3% 53.5%

Misc. Links:
Mish's Global Economic Trend Analysis: Jobs Expand by 151,000, Unemployment Steady at 9.6%; Birth-Death Methodology Changes for the Better; Reflections on the Numbers

Yes, A Recovery Did Begin - NYTimes.com

What we should learn from a big week in the US economy | Gavyn Davies blogs on macroeconomics | FT.com

Econbrowser: The October Employment Situation: Upside Surprise and Shrinking Government

Economists React: ‘Step in the Right Direction’ on Jobs - Real Time Economics - WSJ

Economics One: Empirical Questions About the Anticipation Effects of QE2

Calculated Risk: ADP: Private Employment increases by 43,000 in October

The Tide has not Changed - The Entrepreneurial Mind

You'll Pay the Price for QE2

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