ISM Manufacturing Report Raises Alarm

The light-hearted in economic denial received a wakeup call this morning. As we return from the long holiday weekend, perhaps feeling good about our lives and maybe even the economy, the first economic report to reach the wire offers a slap in the face. ISM’s Manufacturing Index for the month of August, reported Tuesday morning, deteriorated even deeper into territory reflecting sector contraction. While ISM disagrees that it means economic recession, it cannot deny that the situation has deteriorated. As I surveyed the data, I see only signs for concern.

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ISM Manufacturing Report

ISM’s Manufacturing Report on Business for the month of August 2012 produced a headline index, the Purchasing Managers Index (PMI), of 49.6%. Readings below 50.0 reflect sector contraction, and this reading also marked deterioration from July’s 49.8 level. Economists, perhaps having had one too many pina coladas this past weekend, were looking for a reading of 50.0, or improvement. Stocks, which started the day lazily without direction, turned decidedly lower after the report. The SPDR S&P 500 ETF (NYSE: SPY) was down a half point just a few minutes after the release.

August marked the third consecutive month of economic contraction within the manufacturing sector, and this latest reading was the lowest since July 2009. The measure is therefore marking a tough trend. And the deeper we look into the details, the worse signs we find of an economic red tide.

The New Orders Index, a forwarding looking component, dropped significantly to 47.1, down 0.9 from a level of 48.0 in July. This signifies contraction at a faster pace than seen in July, and clearly reflects poorly on global demand for American made goods. The Backlog of Orders Index fell to a sickly 42.5, from 43.0 in July. So, new orders and order backlogs were deteriorated; this is obviously disconcerting. Customers’ Inventories fell a half point to 49.0, but that signifies customers holding less inventory then they should. It also shows a higher level of anxiety among customers of surveyed purchasing managers. Purchasing managers’ inventories are stacking up, with that index now reading 53.0, from 49.0. Given the trends in order backlogs, it’s difficult to see this as a positive.

Production fell 4.1 points, to 47.2, and signs are building that layoffs may be around the corner. This ended a streak of growth that crossed several years. With production lagging, you have to then wonder about employment. The Employment Index eased to 51.6, from 52.0, as the lagging indicator starts to see impact. Take note, as this was the lowest reading for the index since November of 2009. Global demand for American goods remains soft, as the Export Index reached 47.0, up 0.5 points from July, but still reflecting contraction. Imports fell 1.5 points, to 49.0.

There’s no denying any longer that the global disease founded in Europe is spreading to our shores. Eight of eighteen industries are reporting contraction now, as eight report growth and two were unchanged. Anecdotal evidence supports the case we’ve made as panel participants mostly expressed concern about global economies and noted decreased demand for goods.

Only prices seemed to be rising, which is obviously not healthy when demand is declining. Some of the respondents indicated that the drought in the U.S. affected prices in August. Certainly, corn prices increased in August, but fuel prices did as well. Industrial metals continued to mostly decline in price, with nickel, copper, aluminum and steel lower. These are bad signs for the likes of Alcoa (NYSE: AA), BHP Billiton (NYSE: BHP), Rio Tinto (NYSE: RIO), Vale S.A. (Nasdaq: VALE) and Freeport McMoRan Copper & Gold (NYSE: FCX). Investors are not missing that point today either.

Company & Ticker	Midday Price Change
Alcoa (NYSE: AA)	-1.4%
BHP Billiton (NYSE: BHP)	-1.2%
Rio Tinto (NYSE: RIO)	-1.5%
Vale (Nasdaq: VALE)	-2.6%
Freeport-McMoRan (NYSE: FCX)	-1.6%

Industrials are down in concert, with the Dow Jones Industrial Average Index ETF (NYSE: DIA) off 0.8% and the Industrial Select Sector SPDR (NYSE: XLI) off 1.4% at the hour of scribbling here. Major manufacturers are split, depending on industry, with General Electric (NYSE: GE) down 0.7%, Caterpillar (NYSE: CAT) off 3.1% and Ford (NYSE: F) higher by 1.0%, as autos report monthly sales.

I advised on the sale of industrial stocks and basic materials shares two months ago. In the near-term, there may be some lift ahead of and into the September Federal Open Market Committee meeting. After that, I expect global deterioration will only accelerate, especially if geopolitical triggers are pulled as I also expect.

What we’ve recorded here is the worst of the last three months’ contraction in the overall PMI and the New Orders Index. It is therefore a bad sign for the economy, but because the manufacturing sector represents a small portion of the economy, historically, it has not been associated with recession at similar levels. Still, I think the writing is on the wall and deterioration is evident. In my view, layoffs will be the next news driver from the sector, though perhaps not as soon as Friday’s employment report. Construction would seem to be offering a stabilizing factor, but the latest data reported today for the month of July showed a 0.9% drop in construction spending. So, all the news is bad today for the economy, and stocks are pulled by that red tide.

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