The Institute for Supply Management's (ISM) Non-Manufacturing, or Service, survey rose in October to 54.3 from 53.2 in September. Like its venerable brother, the Manufacturing survey, this is a “magic 50” index where any reading above 50 indicates that the economy is expanding and anything below 50 represents an economic contraction.
Thus, this means that the service side of the economy, which is far larger than the manufacturing side, is not only growing, but the rate of growth accelerated in October relative to September. However, that absolute level of the index at 54.3 is just OK, not spectacular. Still, the number came in much better than the 54.0 consensus expectation.
Like the Manufacturing survey, this index is made up of ten sub-indexes that roughly correspond to the manufacturing sub-indexes. In this recovery, the manufacturing side of the economy has been stronger than the service side. That still remains the case, as the Service index is still lower than the 56.9 level on the manufacturing index. The manufacturing index was reported on Monday, and was also stronger than expected.
Results by Sub-Index
Eight of the sub-indexes increased and two fell on the service side this month, and nine are above the "magic 50" level. Furthermore, the strength was in some of the more important of the sub-indexes.
The most important measure of current business activity is, well, the business activity sub-index. It jumped 5.6 points this month, and still remains comfortably over the 50 level at 58.4. Ten industries reported higher business activity and three reported a slowdown in activity.
The most important index for the very short term future is the backlog of orders index. That rose by 4.0 points and encouragingly it rose back above the 50 mark.
There were seven industries reporting an increase in backlog, and three with a decline. However, if we look just a little bit further ahead, the key sub-index is the number of new orders. There the news is also positive, with a rise of 1.8 points to 56.7. However, there were ten industries reporting higher new orders and three reporting declines. The healthy increase in the new orders sub-index though greatly lagged the 7.8 point increase on the manufacturing side reported on Monday.
With the big employment report coming up this Friday, the employment sub-index is also very important. The 0.7 point increase is encouraging, but hardly exciting. We are on the right side of the 50 mark -- but just barely, at 50.9.
The manufacturing side of the economy still looks much stronger according to the ISM data. In recent months that has not really been confirmed by the BLS payroll numbers. Also, this data is directly contradicted by the ADP data released this morning that showed the Service side of the economy adding 77,000 jobs and manufacturing losing 12,000 jobs in October. However, ISM puts construction in the non-manufacturing index, while it is part of the goods producing sector in the ADP data, so some of the difference is simply by definition.
Service Sector Employment
Employment growth in the service sector (which, after all, employs far more people than does manufacturing) is just barely into positive territory (it has been bouncing around the 50 level for several months now). Seven industries reported an increase in payrolls and eight reported a decline. The breakdown of private sector job creation/loss in the Employment report later this week should be interesting.
By far the biggest decline this month on the service side came from export orders, with a 2.5 point drop, but it is still at a healthy level of 55.5. We traditionally run a trade surplus in services, but it is not nearly enough to offset the massive trade deficit on the goods (manufacturing) side.
The decline in export orders on the service side is a bit surprising given a big 6.0 point jump on the manufacturing side, and given the weakness of the dollar, which should make U.S. firms more competitive abroad. The import index on the service side rose 1.0 point to 54.0, also in contrast to the manufacturing side where the import sub-index plunged 5.0 points to 51.5.
At this point, a weak dollar is what the economy needs. It will result in higher exports and lower imports, and should help make a dent in the trade deficit, which is a far bigger short-term problem for the economy than is the budget deficit.
In Summation
Overall, this was a good report. It is highly unlikely that the economy will slip back into a double-dip recession if the ISM service index, and the manufacturing index are both above the 50 mark.
As the report was above expectations, the stock market should like it. The acceleration in growth is very welcome, but we are going to need a lot more if were are going to make a serious dent in the unemployment rate, and be able to eventually move from being in a recovery to actually being in an expansion (recovery being the point from when the economy stops falling -- June 2009, according to the NBER -- until real GDP reaches its previous peak; expansion being any growth beyond that peak. Thus, as a result, the early part of a recovery is just as painful as the latter part of the recession; the end of the recession is simply crossing the stream at the bottom of the valley and starting up the other side).
The table below comes from the ISM report (http://www.ism.ws/ISMReport/NonMfgROB.cfm) and shows the sub-indexes for the service index, as well as the corresponding sub-indexes on the manufacturing side.
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.