What Is Not Seen

The latest manufacturing report came in stronger than expected according to the financial media. With a reading of 48.6% the ISM manufacturing PMI increased with 0.3% since February. On this news, markets reacted strongly with a broad surge in prices.

The ISM PMI index consists of 4 different sub indices; New Orders 20%, Production 20%, Employment 20% and Supplier Deliveries 20%. A reading above 50 has historically meant that the over all economy is growing. A reading below 50 on the other hand has historically meant that the economy is slowing. Today’s reading of 48.6% does clearly signify that the US economy is in a decline.

That the US economy is experiencing severe problems is nothing new. But why markets and the media believe the manufacturing report was god news is a bit harder to reconcile.
A closer look at the report show additional weakness:

Both New Orders and Production recorded lower readings of -2.6% and 2.0% for Mars. A production figure of 48,7% is significantly lower than the 49,9% which is consistent with higher readings of Federal Reserve Board’s Industrial Production. The 8% increase in prices paid is especially troublesome, showing additional distress and downward pressure on profit margins for companies in the manufacturing sector. This reading is also in line with the over all inflation picture where last CPI recorded above 4% yoy.

The mars surge in prices is the 15th consecutive month of higher prices. This is a direct effect from earlier credit expansion. What we now se is squeezing profit margins for many companies. Hadn’t it been for the FED recent attempts to devalue the dollar against other currencies, many more companies would now have felt the effects of higher costs of production with falling demand.

The ISM report is not just a good indicator for the manufacturing sector but also for the over all economy. I don’t think anyone has missed the popular commentary by journalist and economist a like that US is a consumer based economy. And according to GDP it is, as GDP consists of a total 70 % consumer spending. Because GDP only measures what happens in the final stage of production that is in consumer related production, a whole lot is ignored especially what goes on in the manufacturing sector.

By looking at the broader statistic provided by the Bureau of Economic Analysis, Gross-Output, total spending in the US economy is approximately $24 trillion. With GDP of $13 trillion, industrial spending including spending on manufacturing can be estimated roughly to $14,9 trillion. This would imply that consumer spending constitute only 38 % of total economic spending not 70 % according to the GDP. The other 62% can be subscribed to spending in earlier stages of the production process, in particular manufacturing.

The low reading of last ISM number, althogh it is only a survey, it is an important indicator of the over all helath of the american economy. Also together with three indicators other than ISM, a reading below 50 has historically and significantly predicted recession. The other three indicators are: credit spreads (Paper-Spread), return in the S&P 500 and the yield curve.