Despite gain in new orders, manufacturing output remains down, says ISM

The Institute for Supply Management (ISM) reported today that manufacturing activity again contracted for the fourth straight month.

In its Manufacturing Report on Business, ISM said that the PMI, its index to measure growth, was 48.2 in January (a reading of 50 or higher indicates growth), which was 0.2 percent ahead of December but below the 50 mark for the fourth month in a row going back to October’s 49.4. October marked the first month that the PMI was below 50 since November 2012. The current PMI is 2.7 percent below the 12-month average of 50.9. Even though the PMI was again down, ISM noted the over all economy has seen growth for 80 months in a row.

Two of the report’s four key metrics, which includes the PMI, were down in January.

Employment fell 2.1 percent to 45.9 and contracted for the second month in a row. And new orders, which are often cited as the engine that drives manufacturing, headed up 2.7 percent to 51.5 and returned to growth mode following two months of contraction. Production was up 0.3 percent to 50.2, returning to growth after two months of contraction.

ISM said that of the 18 manufacturing sectors contributing to the report, only eight reported growth in January, including Textile Mills; Wood Products; Miscellaneous Manufacturing; Printing & Related Support Activities; Furniture & Related Products; Computer & Electronic Products; Machinery; and Electrical Equipment, Appliances & Components.

Comments submitted to the report by ISM member respondents were mixed depending on industry.

A petroleum & coal products respondent said that the oil and gas sector continues to be challenged by low oil and gas prices, adding that suppliers filing for bankruptcy and reducing their workforce is becoming an increasing risk. A transportation equipment respondent said that business remains strong but is slowing, and a miscellaneous manufacturing respondent said the medical device market continues to be strong.

While the PMI was again down, Brad Holcomb, chair of the ISM Manufacturing Survey Business Committee, said in an interview that there is cautious reason for optimism stemming from January’s strong new orders data.

“It moved nicely into growth territory and is a very bright spot in this report,” he said. “Production has come along as well in returning to growth mode. Those two are trying to pull up the PMI while supplier deliveries (up 0.2 percent to 50.0; a reading below 50 indicates faster deliveries) is absolutely neutral so the thing pulling down the PMI is first and foremost inventories (unchanged from December at 43.5 and still contracting). This is a lingering effect of reducing inventories to close the books well in December, and nobody is ready to increase inventory levels yet. But if new orders growth continues, then inventories have to follow suite.”

The decline in employment could very well strongly relate to releasing temporary holiday workers, which makes it less of a concern, as there are still strong levels of employment, he added.

In assessing the inventory data, which has received a fair amount of attention on both the manufacturing/industrial and consumer sides, Holcomb explained that what is currently happening is more strategy-based than seasonal-based.

“Businesses had a bit of a struggle last year trying to cope with low oil prices and were wondering which way things were going so they wanted to hold down inventories to a very lean, if not artificially lean, level,” he said. “That has bled into January, but I would see that starting to go back up, assuming new orders comes along as well. That is what we need and are hoping for right now. As long as nothing new pops up as a detractor or a headwind I think we have every opportunity to see new orders continue to improve.”

Looking at the global economy and as it relates to manufacturing, Holcomb said that global growth, specifically in China, is a major key, as some of what is happening in light of the well-documented current state of China’s economic decline is based on perception and some is based on reality.

That combination has the subsequent aftereffect of impacting consumer confidence in the U.S., he explained.

“We need positive affirmation of who we are and what we are doing to get people to take their hands out of their pockets and go back to retail stores, while manufacturing is still strong,” he noted. “It is more attitude than anything else, barring something else we have not seen yet.

IHS Global Insight US Economist Michael Montgomery was not sold on the report’s hints of growth based on comments he wrote in a research note.

“[New] Orders and production both bounced over 50, at 51.5 and 50.2, respectively, but neither reading is too convincing,” he wrote. “The 50.2 for production may have just exceeded low expectations (in the seasonal factors) by not having been racked by storms as the winter storm Jonas may have come too late to affect many respondents. The token improvement in the overall composite was a smidgen better than December, but consisted of weaker manufacturing employment taking away two-thirds of what stronger orders and shipments added. The January tally for the ISM changes nothing in the outlook, as it merely confirms the ‘more of the same’ label. The inventory problems are also visible in the report with a 51.5 tally for customers’ inventories being too high. Both drags will weight on most, if not all, of the first half of 2016. The strong dollar and excessive system-wide inventories are each individually enough drag to slow manufacturing to stagnation, but together they trigger minor retreat. Neither is as bad as falling sales would be, and indeed, both negatives together are not as bad as falling sales. Actual sales gains are only just above mediocre, however, and two drags trump mediocre sales.”