Manufacturing Sector Surprises Markets as Activity Rebounds

By Rom Badilla, CFA

October 2, 2012

U.S. manufacturing activity expanded in September signaling better growth for the U.S. economy according to data released yesterday. The Institute for Supply Management released the results of its survey of over 300 manufacturing companies today which shows expansion for the sector. The ISM Manufacturing Index for September improved to a reading of 51.5 which is above the previous month’s print of 49.6. Economists were expecting a sideways move as evident by the median forecasts of 49.7.The September print signals a return to growth in the manufacturing sector after three straight months of contraction.

ISM Manufacturing and Recessions

A reading below 50 represents contraction in the manufacturing sector while above this threshold suggests growth. A significant downturn in manufacturing activity usually rolls up into the broader economy since an index reading in the low 40’s spells a looming recession. Conversely, a number in the high 50’s suggests a robust expansion for the U.S. economy. Weaker economic growth usually translates into lower stock prices and falling bond yields and vice-versa.

The components of today’s release justified the strength as key sub-indices improved from August. New Orders which is a gauge of future demand of durable goods increased 5.2 to 52.3. Like the headline number, this is a return to growth New Orders after staying below 50 the past three months. The Employment sub-index increased as well to 54.7 from 51.6 in August.

While key components were up, some declined or remained in contractionary territory. Inventories decreased 2.5 from last month to 50.5. Demand for U.S. manufactured goods improved slightly and is less contractionary as the New Export Orders component improved from 47.0 to 48.5. Similarly, Production improved by 2.3 but remains below the threshold with the September print of 49.5. Given the uptick in demand as evident by the higher New Orders, Production should rise in the months ahead.

As mentioned last month, the recent rebound in energy prices and surge in commodities due to the recent drought is playing its way into prices which may place upward pressure on inflation. The Prices Paid component moved higher to 58.0 from 54.0 in August. The last two months of expansionary prices contrasts with the prior two months reading of 39.5 and 37.0.

While today’s release in both the headline and the New Orders component is an improvement from the previous months, the fact is that the reading continues to dance near the threshold which is still a concern. Given the current backdrop of the European Debt Crisis and the impending Fiscal Cliff, the weakness in the regional manufacturing surveys such as the Empire State and Philadelphia Fed does not signal any major future changes for the national number which in turn should spell continued lackluster growth for the economy. As a result and after the Federal Reserve stated before that policy will remain even in the face of robust economic growth, bond yields will remain low for the time being.

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