Beginning of the End for Service Sector

Service Sector Stall?

Tuesday's service sector data release, the ISM Non-Manufacturing Index, disappointed against economists' views. So is this the beginning of the end for the service sector expansion?

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Beginning of the End for Service Sector?

The Institute for Supply Management (ISM) reported its Non-Manufacturing Index for the month of March this week. ISM's NMI fell to 57.3, from the high mark of the last six years set in February at 59.7. While the result also fell short of the economists' consensus, the report was generally positive otherwise. Thus, the popular press did not make much of the change in the rate of expansion, but should they have?

The Non-Manufacturing Index showed a level of activity better resembling December of 2010 than its predecessors in 2011. It was two-tenths higher than December, but well short of January's 59.4 and February's 59.7. Given revelations from the survey, we are openly wondering if we are seeing the start of trend change. Indeed, other economic data, including consumer confidence, seems to offer good enough reason to worry the economy could be headed for rougher waters once more. Some of the catalysts for this are discussed in the paragraphs here following, but they include pressure from rising commodity and energy costs and a vulnerable balance sheet on the small business level.

The survey's Business Activity Index is a widely followed economic barometer in and of itself, and it fell sharply, by 7.2 percentage points in March, to 59.7. Fifteen of eighteen reporting industries showed increased business activity in February, though. Remember, it's the pace of expansion that slowed, not the expansion itself. But as we have said here before, you slow before you stop. Two industries did already report a contraction in March; those were "Other Services" and "Transportation and Warehousing". Among industries reporting expansion were Real Estate, Retail Trade and Finance and Insurance. We don't see much to fear in those details, except for that nagging reality that the pace of expansion eased.

The Survey measures New Orders, and the indicator of future activity only eased off its robust pace, slipping to 64.1, from 64.4 in February. This index is down from its recent peak of 64.9 in January. Some of the comments from survey respondents do more than quell any concern about a downturn. In fact, they point toward the "turn around" materializing. However, these guys are too close to the action to see the bigger picture. They, being corporate American executives, certainly did not foresee the degree of economic decline ahead of them a few years ago, and then they overreacted once caught in the middle of the fire – and in turn fired too many people, in my view. Again though, 16 of 17 queried industries reported growth in March, and only "Other Services" saw a decline.

ISM's Non-Manufacturing Employment Index also gave ground in March, which is of course inconsistent with the employment report data. The Employment Index fell to 53.7, from 55.6 in February, reflecting still cautious hiring activity, which fits with our analysis of labor. That said, 11 of 18 industries surveyed still reported increased hiring in March. The respondents' comments reflected less enthusiasm than with regard to some of the other activity, some even reporting hiring freezes still in place. Industries reporting reductions in workforce included Educational Services, Finance and Insurance and Health Care and Social Assistance. Two of these are of course pressured by public sector budget cutting and decreased spending generally.

Supplier Deliveries reflected a different dynamic, with that index falling to 51.5. Inventory levels were reported about the same, but companies dealing with Japan reported stockpiling of product in anticipation of a supply squeeze. The Backlog of Orders Index grew in March, however, 45% of respondents do not measure backlog of orders. The New Export Orders Index increased, so the driver of manufacturing demand is drawing on our services sector too. Imports dropped though to about break-even.

Here's a problem: 37% of respondents said their inventory levels were too high in March, versus 23% reporting this in February. This is a sign, of course, that purchasing managers (in services) are sensing a slowing business environment. A second issue is raised for services companies within the Prices Paid Index, which shows some 51% of respondents reported higher prices paid for supplies and services. Only 2% reported lower prices, and all 18 industries reported price increases. This puts pressure on profit margins and impacts the hiring decision, however, less than sales activity does.

In conclusion, it looks like the message is, keep an eye on services, as this lulling of activity could be an early sign of something more important. Or, it could simply be due to temporary effects of chaos overseas, in Japan and the Middle East, affecting business activity by introducing uncertainty. It is more likely the result of the Middle East impact on fuel prices and energy prices though, not to mention consumer sentiment and spending. If energy prices continue higher or even remain at current levels, you can expect a meaningful impact to GDP, so there should be no surprise in our warning.

Article interests Omnicom (NYSE: OMC), Interpublic (NYSE: IPG), Focus Media (Nasdaq: FMCN), Monster Worldwide (NYSE: MWW), ValueClick (Nasdaq: VCLK), QuinStreet (Nasdaq: QNST), ReachLocal (Nasdaq: RLOC), Visa (NYSE: V), Mastercard (NYSE: MA), Fidelity National Information (NYSE: FIS), Fiserv (Nasdaq: FISV), Moody’s (NYSE: MCO), Verisk Analytics (Nasdaq: VRSK), Cintas (Nasdaq: CTAS), Global Payments (NYSE: GPN), R.R. Donnelley & Sons (NYSE: RRD), Mercadolibre (Nasdaq: MELI), Total System Services (NYSE: TSS), Rollins (NYSE: ROL), Lender Processing (NYSE: LPS), FleetCor Technologies (NYSE: FLT), OpenTable (Nasdaq: OPEN), HMS Holdings (Nasdaq: HMSY), Vistaprint (Nasdaq: VPRT), SAVVIS (Nasdaq: SVVS), Wright Express (NYSE: WXS), Quad/Graphics (Nasdaq: QUAD), GSI Commerce (Nasdaq: GSIC), Greendot (Nasdaq: GDOT), Giant Interactive (NYSE: GA), Athenahealth (Nasdaq: ATHN), Emdeon (NYSE: EM), Portfolio Recovery Services (Nasdaq: PRAA), Deluxe (NYSE: DLX), Maximus (NYSE: MMS), ABM (NYSE: ABM), CoStar (Nasdaq: CSGP), Fair Isaac (Nasdaq: FICO), Healthcare Services (Nasdaq: HCSG), Synnex (NYSE: SNX), TeleTech (Nasdaq: TTEC), XXXXXXXXXXX McDonald’s (NYSE: MCD), Yum Brands (NYSE: YUM), Chipotle Mexican Grill (NYSE: CMG), Tim Horton’s (NYSE: THI), Darden (NYSE: DRI), Brinker (NYSE: EAT), Marriott International (NYSE: MAR), Starwood (NYSE: HOT), Hyatt (NYSE: H), Expedia (Nasdaq: EXPE), Wyndham Worldwide (NYSE: WYN), Choice Hotels (NYSE: CHH), Home Inns & Hotels (Nasdaq: HMIN), Gaylord Entertainment (NYSE: GET), Orient-Express (NYSE: OEH), China Lodging (Nasdaq: HTHT), Comcast (Nasdaq: CMCSA), DirecTV (NYSE: DTV), Viacom (NYSE: VIA-B), Time Warner Cable (NYSE: TWC), Discovery (OTC: DISCA), Dish Network (Nasdaq: DISH), Cablevision (NYSE: CVC), Liberty Global (OTC: LBTYA), Shaw Communications (NYSE: SJR), Virgin Media (Nasdaq: VMED), Charter Communications (Nasdaq: CHTR), TiVo (Nasdaq: TIVO), Crown Media (Nasdaq: CRWN), CBS (NYSE: CBS), Scripps Networks (NYSE: SNI), CTC Media (Nasdaq: CTCM), Central European Media (Nasdaq: CETV), Bally (NYSE: BYI), Pinnacle (NYSE: PNK), Churchill Downs (Nasdaq: CHDN), The9 Limited (Nasdaq: NCTY), Multimedia Games (Nasdaq: MGAM), Dover Downs (NYSE: DDE), Asia Entertainment (Nasdaq: AERL), Walt Disney (NYSE: DIS), Time Warner (NYSE: TWX), Warner Music (NYSE: WMG), World Wrestling (NYSE: WWE), UPS (NYSE: UPS), FedEx (NYSE: FDX), Delta (NYSE: DAL), United Continental (NYSE: UAL), China Eastern (NYSE: CEA), China Southern (NYSE: ZNH), AMR (NYSE: AMR), US Airways (NYSE: LCC), Apollo Group (Nasdaq: APOL), Hertz (NYSE: HTZ), Ryder (NYSE: R), United Rentals (NYSE: URI), Carnival (NYSE: CCL), Priceline.com (Nasdaq: PCLN), Six Flags (NYSE: SIX), Orbitz (NYSE: OWW), Las Vegas Sands (NYSE: LVS), Wynn Resorts (Nasdaq: WYNN), MGM Resorts (NYSE: MGM), Melco Crown (Nasdaq: MPEL), Penn National (Nasdaq: PENN), Vail Resorts (NYSE: MTN), Ameristar (Nasdaq: ASCA), Boyd Gaming (NYSE: BYD), Western Union (NYSE: WU), H&R Block (NYSE: HRB), Weight Watchers (NYSE: WTW), Ulta Salon (Nasdaq: ULTA), Service Corp. (NYSE: SCI), VCA Antech (Nasdaq: WOOF), Hillenbrand (NYSE: HI), Regis (NYSE: RGS), PrePaid Legal (NYSE: PPD), Accenture (NYSE: ACN), Gartner (NYSE: IT).

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