ISM Better than Expected - Analyst Blog

The Institute for Supply Management’s (ISM) Manufacturing index fell in July to 55.5 from 56.2, but the decline was far less than the expected level of 54.2. Any reading over 50 indicates that the manufacturing sector of the economy is expanding. Thus the expansion continues, but at a somewhat slower pace than in June.

This is the 12th straight month that the index has been above 50. Nine of the ten sub-indexes that make up the overall index are over the magic 50 level. Four of the sub-indexes declined, and six rose. However, two of the most important of the sub-indexes declined sharply.

The sub-index that is the best gauge of current activity -- the production index -- tumbled by 4.4 points, but remains well in the expansion zone with a reading of 57.0. Similarly, the most important indicator about the near future -- new orders -- fell by 5.0 points, but is still well above 50, at 53.5. The backlog of orders sub-index also fell by 2.5 points, but at 54.5 is still healthy on an absolute basis.

On the other hand, the employment sub-index is at 58.6, a gain of 0.8 points, indicating that manufacturers were still adding to jobs in July. That is a very healthy reading, and means that at least we should see private sector job gains from that (now relatively small) part of the employment picture when the numbers come out on Friday morning.

The biggest increase came from the inventory component, indicating that inventories are going up, particularly at the firms themselves, but also to a lesser extent at their customers, although the customer inventory sub-index is the only one that remains below the 50 mark.

For each sub-index, the report highlights the industries that are reporting improvement or deterioration. This month, one of the industries that was consistently showing up in a positive light was paper products. That probably means good things for the likes of International Paper (IP), MeadWestvaco (MWV) and Weyerhaeuser (WY).

The strength in paper will offset some of the weakness those companies face on the lumber side, due to the weak new home market. On the other hand, the Food, Beverage and Tobacco products industry seems to be consistently on the wrong side of the lists. That could mean tougher times ahead for the likes of Kraft Foods (KFT) and PepsiCo (PEP).  

Overall, while the smaller-than-expected decline is good news, when one digs deeper into the sub-indexes, there is still a fair amount to be worried about. The report does not lend much support to those who think that the economy is in the process of falling into a double-dip recession. However, it is pretty clear that the pace of growth is slowing; it seems likely at this point that growth in the third quarter will be somewhat below the 2.4% growth rate in the second quarter (see here for a review of the quarter). That sort of growth will not put much of a dent in the unemployment rate and indicates that the economy still needs more fiscal stimulus.

The table below comes from the ISM report, which if you are interested in reading in full can be found here.

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.

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