No one likes to see the Institute for Supply Management's U.S. manufacturing index dip into contraction territory, as it did in November. But the details of the ISM's closely watched report suggest this may be just a temporary hiccup.
Monday's report showed that the manufacturing ISM dipped distressingly to 49.5, from 51.7 in October. In this index, any number below 50 represents a contraction of activity; while economists were wary the report might show tepid growth, only the most bearish of prognosticators had anticipated an outright decline. (Bloomberg surveyed 83 economists; only two of them predicted a reading below 50.)
The idea of a U.S. manufacturing slowdown, at a time when the world's other economic engines are themselves misfiring, is not something investors were eager to see. Indeed, the Dow Jones industrial average shed nearly 100 points from Monday's pre-ISM highs, and Canadian stocks turned downward in concert.
However, the report comes with enough asterisks to give rise to some optimism.
One of the biggest declining components within the ISM index in November was the inventories segment, which slumped to 45 from 50. Given that a bigger-than-expected buildup of inventories was a key contributor to last week's big upward revision in U.S. third-quarter gross domestic product, it's hardly a surprise that manufacturers would be working down those inventories. And this fall in inventories came even as the new-production component actually rose, to 53.7 from 52.4.
New orders took a dip – to 50.3 from 54.2 – which would normally be a worrisome indicator. But the spread between inventories and new orders actually widened in the month, to 5.3 points from 4.2; orders were still growing, albeit at a slower pace, at the same time as supplies in inventory were dropping. When orders are outpacing inventory, it typically means that companies will need to step up their production to meet the coming demand – which implies that a rebound in the ISM numbers could be just around the corner.
That is, unless the declining pace in new orders is the start of a trend – a generalized slump in buying. Indeed, some economists are already suggesting that buyers are sitting on their hands for fear that a failure to resolve the U.S. fiscal crisis will gut the economy at the start of next year, leaving them holding supplies they can't use. The flip side of this, of course, is that Washington budget negotiations will avoid the so-called fiscal cliff before we reach it – unleashing a load of pent-up demand that would kick-start the manufacturing sector in January, if not sooner.
Finally, there's a good chance the weakness seen in November, particularly on the orders side, has little to do with a an economic slowdown or fiscal fears – and much more to do with Hurricane Sandy. The massive storm, which crippled large portions of the U.S. Eastern Seaboard when it hit at the end of October, certainly made a big dent in activity for a wide range of businesses for the first part of November. A return to normal conditions in December could bring manufacturing activity quickly back on track, too.
David Parkinson