Monday, March 07, 2011

A Macro View: ISM Reports February 2011

Even before the national ISM Manufacturing report came out, the regional reports were strong. For example, Calculated Risk says Chicago PMI Strong in February and Cullen Roche noted a Strong Reading for Chicago ISM Report. Also from Calculated Risk comes Dallas Fed: Texas Manufacturing Activity Picks Up where they show the strong correlation between average all Fed surveys and ISM PMI index (manufacturing).

The World-Wide Factory Activity list provided by WSJ shows expansion in most industrial countries and most increasing production at an increasing rate. This fact is borne out by 17 countries expanding faster and only 5 expanding slower. Australia jumped from contracting to expanding with a jump of 4.4 points to 51.1%. International comparisons are always wrought with non-comparable data and noise in the data, so while PMI indexes deal mostly with business sentiment, it is not likely these figures can be so precisely ranked from top to bottom. More than likely it should be grouped into segments like ones under 50 indicating contraction and countries over 60 indicating rapidly expanding sectors. The US was not top overall but was in the top 6 over 60 in the index.

The manufacturing indexes for the US and UK converged last month with the UK dipping slightly and the US expanding. David Smith notes the strong showing that signifies a 10% growth in manufacturing at Manufacturing doing very nicely, and he states, "After years in the doghouse, Britain's manufacturing sector is doing well, on the back of global economic revival and a competitive pound..." But on another blog post he sees anemic growth in the services sectors that will produce overall ‘flattish’ GDP growth over the last 6 months at Service sector bows to manufacturing.

China is marked by anemic growth in the manufacturing sectors as noted in the earlier link to the WSJ article on factory activity with a decrease of 0.7 last month to 52.2%. Although Cullen Roche states different PMI indexes for China (February at 51.7, down from 54.5 last month) he still indicates that the manufacturing sector is increasing but at a much slower pace (China Flashing Warning Sign: PMI Shows Sharp Declines). On his link to the article 5 BULLISH AND BEARISH CHARTS FOR 2011 he considers China's rising inflation as a bearish sign for the world economy. First, I am not certain that the world is so dependent on their growth for worldwide growth, especially considering that most of the world was contracting while the Chinese claimed their economy suffered only modestly. Many developing nations have missed the latest opportunities to get on the development escalator and would jump at the opportunity to take up any slack in manufacturing that China leaves behind. Secondly, if inflation is the main concern then weak manufacturing should tame that beast. So not sure what his point is unless he thinks the world is so dependent on China that only a Goldilocks economy (not too hot, not too cold, just right) will prosper the world.

That's fine about the world, we want to know about the US!
Although a minor increase in the index for both headline numbers, it was a surprise to the upside for both Econoday and MarketWatch. Econoday expected slight decreases in the indexes of a 0.4 for ISM Non-Mfg Index to 59% and 0.3 for ISM Mfg Index to 60.5% while WarketWatch expected the same number as last month for non-manufacturing at 59.4% and a slight increase of 0.2 to 61%. The actual numbers reported by the ISM was 59.7% for the Non-Manufacturing ISM Report and 61.4% for the Manufacturing ISM Report . Both numbers easily fell within the consensus range for Econoday with a range stated of 58.7 to 62% for manufacturing and a wide range of 57.8 to 65.1% for non-manufacturing. The strength in both sectors have been noted by Mark Perry at Carpe Diem noting that the ISM Non-Manufacturing Business Activity Index Surges To 7-Year High and to get a higher reading on the ISM manufacturing index you would have to go back to 1983 and meeting the same level as in May 2004.

Beyond the headline numbers being in the respectable 60sh range, the individual components of the ISM reports also showed considerable strength. Business activity/production increased 2.8 to 66.3% for manufacturing and 2.3 to 66.9% for non-manufacturing. New orders maintained its very acceptable levels in the mid-60s with a small drop of 0.5 for non-manufacturing and a slight increase for manufacturing of 0.2 which resulted in index number of 64.4% and 68% respectively. New export orders increased nicely for non-manufacturing of 3 points to 56.5% and a smaller increase for manufacturing of 0.5 to an outstanding 62.5% which portents continued strength in the economy.

Jobs, Jobs, Jobs
The all important employment indexes with respect to this economic recovery also showed considerable strength with the index raising 2.8 to an outstanding 64.5 in manufacturing. While a smaller increase of 1.1 to an index of 55.6% for non-manufacturing was reported, this signifies the continued upward trend of the biggest driver in the economy for employment. This is a good time to see the index for the employment non-manufacturing index since December 2009 along with its trend line. Since last posted for the December report the slope of the trend line increased 0.1 to about a 0.6 increase per month and the R^2 rose to under 0.73 from just over 0.58. This means that the trend line is increasing and that even with more months the significance of trend is greater. (Click on tables for clearer images.)

Along with the good employment news from the ISMs, last weeks initial unemployment claims dropped significantly and got plenty of economists to note that this might show signs of an improving labor market. Calculated Risk stated it best at Calculated Risk: Weekly Initial Unemployment Claims decline sharply, 4-Week average below 400,000.
There is nothing magical about the 400,000 level, but breaking below 400,000 is a good sign. The sharp drop in weekly claims suggests improvement in the labor market.

Indeed, as I have stated before nothing is magical about one number or another although there may be infliction points. Others statements are: 1. Andrew Samwick hopes it is good news that Initial UI Claims Cross 400,000; 2. The Capital Spectator asks Is The Stalled Decline In Jobless Claims Really Over This Time?; 3. Mark Perry thinks that "labor market is gradually stabilizing" at CARPE DIEM: Jobless Claims Fall to 2-1/2 Year Low.

Same Structural Rigidity and More of It
...Hayek's contention that 'the economic problem of society is mainly one of rapid adaptation to changes...'

While at a Macro View of the Markets blog posts talk in terms of structural rigidity, the scholarly understanding is often in terms of flexibility which is just the absence of structural rigidity. This concept of flexibility is defined by Tony Killick in the following quote.
Broadly expressed, we can define a flexible economy as one in which individuals, organizations and institutions efficiently adjust their goals and resources to changing constraints and opportunities.

Given that we can still see structural rigidity in both reports, the price index continues on increasing at an even faster rate. Non-manufacturing price index moved up 1.2 to 73.3% maintaining its strong above 70 mark, and manufacturing increased less at 0.5 but still maintaining its astronomical above 80 mark at exactly 82%. Along with high levels of the price indexes, the ratio of firms reporting rising prices is very high to firms reporting lower prices. Non-manufacturing had 4% of firms reporting lower prices while 46% reporting higher prices. Manufacturing as before had an even higher ratio of 66% reporting higher prices and only 2% reporting lower prices.

Last month showed continued number of commodities with rising prices. Manufacturing showed not much change in total number of commodities with prices rising at around 30 but multi-months rose to 21 from 15 last month. Non-manufacturing showed the more dramatic changes of commodity prices with multi-months rising to 19 from 14 and 7 the month before. Also the number of commodities that have rising prices is 41 up from 28 last month and 23 the month before that. Clearly the trend is that more commodities are having prices rise and then multi-months as the secondary effect.

What Respondents are Saying?
Just like the reports showed increasing business activity but growing price pressures, respondents also spelled this out in detail.
# "Our plants are working 24/7 to meet production demands." (Fabricated Metal Products)
# "Capital projects moved from inactive to active" and "Award of long-awaited contracts."
# "Business environment is generally improving." (Management of Companies & Support Services)
# "We are seeing strength in our business both from the perspective of new business and expansion with our existing customers." (Finance & Insurance)
# "Strong demand; capacity crunch all around." (Transportation & Warehousing)
# "Major uptick in business activities." (Accommodation & Food Services)

But prices of inputs are constraining business growth.
# "A continued weak dollar is increasing the cost of components purchased overseas. It is going to force us to increase our selling prices to our customers." (Transportation Equipment)
# "We continue to see significant inflation across nearly every type of chemical raw material we purchase." (Chemical Products)
# "Commodities are once again putting significant pressure on prices and capacity." (Retail Trade)

Good news is coming out about the labor markets and the ISM reports confirm this trend. The reports continue to show signs of structural rigidity and more broadly in the markets. At some time the Fed will need to start on a contractionary monetary policy or at least to unwind its positions. This seems to be an exceptional time to tackle the deficits although even modest proposals by the Republicans have generated quite a backlash even among right of center institutions {supposedly}. For example John B. Taylor says that Goldman Sachs Wrong About Impact of House Budget Proposal. Where GS claims that "the House proposal would reduce economic growth in the second and third quarters of this year by 1.5 to 2 percent if enacted into law next month." My question would be what would GS expect if the budget was actually balanced? Something like a contraction of 20-30%?

Misc. Links:
Recession's Over, Economy's in Recovery: It's Time for Some Gloom and Doom from Time Magazine

Market Watch Forecast:
Manufacturing: 61.0%
Non-manufacturing: 59.4%

Calculated Risk: ISM Non-Manufacturing Index indicates expansion in February

Calculated Risk: ISM Manufacturing Index increases in February

Chicago Manufacturing Data Indicate ‘Pervasive Growth’

Calculated Risk: Private Construction Spending decreases in January

More Strong News From the Manufacturing Sector - Seeking Alpha

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