Source: Wells Fargo Securities Economics GroupBack-to-Back Months in Contraction Territory
The second straight month of ISM readings in contraction territory is not a
good sign for the manufacturing sector or the broader economy but it does
not portend imminent recession either. As the top graph shows, the ISM
can briefly slip into contraction territory without leading to recession. But
this is another data point on the wrong side of the ledger. The new orders
component remained negative at 48.0 from 47.8 in the previous month and
the orders backlog fell to 43.0, the second lowest reading since 2009. The
prices paid component, at 39.5, tells us that the input costs of production
are not a hurdle for profitability for most manufacturing oriented
businesses. Taken as a whole, today's report is consistent with our real GDP
growth estimate of 1.1 to 1.2 percent in the remaining quarters of 2012.
Not a Huge Surprise, Given the Deterioration in Other Measures
Across the country, purchasing managers are losing confidence in the
ability of their business to continue to grow. A collective look at the various
purchasing manager indices (PMIs) shows that these diffusion indexes are
straddling the line between slow growth and outright contraction with
some measures like the Richmond and Philadelphia Fed indices firmly in
negative territory, while others like the Empire Index in New York and the
Chicago Fed PMI still modestly in expansion territory.
Implications for Business Spending
As mentioned above, the new orders component came in at 48.0 in July.
The weakness here is particularly troubling as orders outside of the volatile
transport sector have been particularly weak in recent months. Our favored
measure of future business spending is orders for non-defense capital
goods ex-aircraft. In last week's durable goods report, we learned that this
series was falling 3.1 percent at a 3-month annualized rate. With this
measure already falling in June, the continued deterioration in the orders
component in today's report for July raises more doubts about the
sustainability of growth in business spending.
A Disconnect Between the Employment Index and Jobs
Looking at the nearby graph of the ISM employment component and the
actual change in nonfarm payrolls it is evident that relative to the previous
expansion, the growth in payrolls has not been nearly as strong as hiring
intentions expressed in the ISM employment index. The overall job market
is reflective of the overall economy; whereas the ISM index tends to be
more reflective of the manufacturing sector specifically. As manufacturing
has become more capital intensive over the years, hiring in recoveries has
been more muted than in prior cycles. Manufacturing employment actually
peaked in 1979, although some degree of hiring occurs during expansions it
is not enough to return factory sector employment to pre-recession peaks.