ISM manufacturing index shows growth but warning signs persist

The Institute of Supply Management (ISM) has reported that manufacturing activity in July was basically flat compared to June.

The index the ISM uses to measure the manufacturing sector, or PMI, was 55.5% in July, which is down from 56.2% in June, 59.7% in May, and 60.4% in April. Any reading that is 50 or better represents economic growth. July represents the 12th consecutive month that the PMI is more than 50, coupled with the overall economy on a growth track for 15 straight months.

Norbert J. Ore, chair of the ISM’s Manufacturing Business Survey Committee said in a statement that the manufacturing sector continued to grow during July but at a slightly slower rate than June.

“Employment [58.6% in July compared to 57.8% in June] , supplier deliveries [58.3% in July compared to 57.3% in June] and inventories [50.2% in July compared to 45.8%  in June] improved during the month and reduced the impact of a month-over-month deceleration in new orders [53.5% in July compared to 58.5% in June] and production [57.0% in July compared to 61.4% in June],” said Ore. “July marks 12 consecutive months of growth in manufacturing, and indications are that demand is still quite strong in 10 of 18 industries. The prices that manufacturers paid for their inputs were slightly higher but stable, with only a few items on the short supply list.”

Other notable readings from the July report include: prices at 57.5% compared to 57.0% in June; backlog of orders at 54.5% compared to 57.0% in June, and customers’ inventories at 39.0% compared to 38.0% in June.

Even though the PMI has been down for three straight months, Ore explained that overall the manufacturing sector is relatively healthy and not hindering the economy, despite signs of economic stagnation in recent weeks.

What needs to start happening outside of manufacturing, he said, is an increase in consumer spending and business investment in order for the economy to get going on all cylinders.

“Last month, consumer readings were not good, and that makes you worry a little bit about what is going to happen in the second half,” said Ore. [Another thing] is second quarter Gross Domestic Product at 2.4% subject to revision. We expect the second half of this year to be not as strong as the first half, so a 2.4% second quarter GDP is worrisome heading into the second half of the year, particularly in regards to what the consumer is going to do.”

When asked about the respective 5.0% and 4.4% declines in New Orders and Production in July, Ore said that the drop in New Orders—which is considered a leading indicator of the PMI—is not welcome news, due to the uneven economy. More strength in New Orders, as well as Production, going forward would be welcome in the coming months.
What’s more, Ore pointed out housing has yet to make a full recovery, which is also weighing down New Orders and Production.

“It is a very mixed signal [on the economy] we are getting overall,” said Ore. “If consumer spending picks up, we should be fine. If that does not happen, we will lack the driver for a sustained recovery.”

And the 4.4% gain in inventory levels, shows that inventories continue to grow at a small rate but this jump, according to Ore, needs to be treated as just one month of growth. But he cautioned if there is another increase around the same size in August, inventories will need to be closely monitored and could reflect an “involuntary inventory build up” occurring at a time when consumers and businesses remain cautious with their spending.

Pricing in the PMI appears to have stabilized, falling to its current level of 57.5% compared to 77.5% as recently as May. This decline represents pricing power shifting back to manufacturers, according to Ore. If manufacturers were to start raising prices, he said it would raise the possibility of raw materials’ inflation, and if prices were to dip, there would be deflation which Ore said would be worse.