PMI Shows Expansion

The Institute of Supply Management’s (ISM) Purchasing Managers Index, a closely watched gauge of manufacturing activity, rose to 52.9 in August from 48.9 in June. It was also well above the 50.5 consensus expectations.

With this index, 50 is the magic number that separates expansion from contraction, so this reading is showing growth in the manufacturing sector.  This was the highest reading on the index since June 2007. It is one more strong bit of evidence that the recession is now over.

The index has risen in every month since December when it hit a record low of 32.9. However, all of the previous improvements simply meant that the manufacturing economy was shrinking at a slower pace. This is the first time we have seen an actual expansion in a very long time.

Manufacturing is a relatively small part of the economy, just about 12%, but it is also much more volatile than services are. That volatility makes it more significant as to the overall direction of the economy than its absolute size would indicate. The ISM will have a separate report out on the services sector of the economy on Thursday.

The internals of the report were also very strong, with 11 of the 18 industries it tracks showing improvement, so this is a fairly broad-based recovery. The sub-index for new orders jumped by 9.6 points, to 64.9 from 55.3. The index of current production rose to 61.9 from 57.9.

There were some weak points as well. The employment sub-index is still below 50 at 46.4, but it is an improvement from the 45.6 last month.

If one steps back for a slightly longer perspective, this is still good news. As recently as May, the employment reading was down at 34.3. Yes, the current reading means that we are still losing manufacturing jobs, but at a vastly slower pace than we were just a few months ago. With new orders and production leaping upwards, the first effect is likely to be a big increase in margins, due to an increase in productivity.

The next effect will be that the hours for current workers will increase, including some overtime. Calling in laid off workers is likely the next step, and then, probably several months down the road, hiring of completely new workers. The report would seem to indicate that profits in the industrial sector will be better than expected in the third quarter.

The indexes of inventories continued to show contraction. The index of companies own inventories rose slightly to 34.4 from 33.5, but is still well below the 50 mark. The index of customers inventories is higher, but falling at 39.0 vs. 42.5 last month. Both indexes are indicating inventories are being drawn down. While that’s not good for the current readings, it sets the stage for more expansion in the future.

One industry that seems to stand out when going through the report is paper, which improved in almost all of the categories. Firms like International Paper (IP) and Mead Westvaco (MWV) have been seeing very large increases in their mean estimates for both this year and next, meaning that the companies are probably conveying positive news to the analysts that this report seems to confirm.

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