December 2016 ISM Manufacturing Survey Improved

The ISM Manufacturing survey improved and remained marginally in expansion. The key internals remain mixed. The Markit PMI manufacturing Index, also released today, is in positive territory and improved.

Analyst Opinion of the ISM Manufacturing Survey

ISM manufacturing index movements have correlated with Industrial Production Manufacturing index only half the time in the last 12 months. Based on this survey and the unusually unified district Federal Reserve Surveys (all in expansion, one would expect the Fed's Industrial Production index to be improved in December (note that the hard data last month contradicted all the surveys). Overall, surveys do not have a high correlation to the movement of industrial production (manufacturing) since the Great Recession..Note that new orders sub-index strongly improved.

The ISM Manufacturing survey index (PMI) marginally improved from 53.2 to 54.7 (50 separates manufacturing contraction and expansion). This was slightly above expectations from Bloomberg / Econoday which were 53.0 to 54.7 (consensus 53.8).

Earlier today, the Markit PMI Manufacturing Index was released:

Manufacturing ends 2016 on strong note as PMI hits 21-month high

• Manufacturing PMI rises to 21-month high
• Fastest upturn in payroll numbers since June 2015
• Inventory building accelerates in December
• December data signalled a strong end to the year for the US manufacturing sector, with overall business conditions improving at the fastest pace since March 2015. Robust rises in new orders and production volumes led to the sharpest pace of job creation for a year-and-a-half. Meanwhile, greater client spending and upbeat business confidence resulted in the largest accumulation of preproduction inventories since August 2014.
• Adjusted for seasonal influences, the Markit U.S. Manufacturing Purchasing Managers' Index™ (PMI™) registered 54.3 in December, up slightly from 54.1 in November, to signal the strongest improvement in business conditions for just under two years. The latest rise in the headline index reading was largely driven by stronger rates of employment growth and inventory building in December, which more than offset slightly weaker increases in output and new orders.

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Relatively deep penetration of this index below 50 has normally resulted in a recession.

The noisy Backlog of Orders was unchanged and remans in contraction. Backlog growth should be an indicator of improving conditions; a number below 50 indicates contraction. Backlog accuracy does not have a high correlation against actual data.

Excepts from the ISM release:

Economic activity in the manufacturing sector expanded in December, and the overall economy grew for the 91st consecutive month, say the nation's supply executives in the latest Manufacturing ISM® Report On Business®.

The report was issued today by Bradley J. Holcomb, CPSM, CPSD, chair of the Institute for Supply Management® (ISM®) Manufacturing Business Survey Committee. "The December PMI® registered 54.7 percent, an increase of 1.5 percentage points from the November reading of 53.2 percent. The New Orders Index registered 60.2 percent, an increase of 7.2 percentage points from the November reading of 53 percent. The Production Index registered 60.3 percent, 4.3 percentage points higher than the November reading of 56 percent. The Employment Index registered 53.1 percent, an increase of 0.8 percentage point from the November reading of 52.3 percent. Inventories of raw materials registered 47 percent, a decrease of 2 percentage points from the November reading of 49 percent. The Prices Index registered 65.5 percent in December, an increase of 11 percentage points from the November reading of 54.5 percent, indicating higher raw materials prices for the 10th consecutive month. The PMI®, New Orders, Production and Employment Indexes all registered new highs for the year 2016, and the forward-looking comments from the panel are largely positive."

Of the 18 manufacturing industries, 11 are reporting growth in December in the following order: Petroleum & Coal Products; Primary Metals; Miscellaneous Manufacturing; Food, Beverage & Tobacco Products; Apparel, Leather & Allied Products; Paper Products; Machinery; Electrical Equipment, Appliances & Components; Computer & Electronic Products; Fabricated Metal Products; and Chemical Products. The six industries reporting contraction in December — listed in order — are: Plastics & Rubber Products; Furniture & Related Products; Printing & Related Support Activities; Textile Mills; Nonmetallic Mineral Products; and Transportation Equipment.

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It is interesting to note that ISM Manufacturing represents less than 10% of USA employment, and approximately 20% of the business economy. Historically, it could be argued that the production portion of ISM Manufacturing leads the Fed's Industrial Production index - however the correlation is not strong when looking at trends.

However, holding this and other survey's Econintersect follows accountable for their predictions, the following graph compares the hard data from Industrial Products manufacturing subindex (blue bar) and US Census manufacturing shipments (red bar) to the ISM Manufacturing Survey (purple bar).

Comparing Surveys to Hard Data

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Caveats on the use of ISM Manufacturing Index:

This is a survey, a quantification of opinion - not facts and data. However, as pointed out above, certain elements of this survey have good to excellent correlation to the economy. Surveys lead hard data by weeks to months, and can provide early insight into changing conditions.

Many use ISM manufacturing for guidance in estimating manufacturing employment growth. Econintersect has run correlation coefficients for the ISM manufacturing employment and the BLS manufacturing employment data series above going back to 1988, using quarterly data. The coincident correlations are actually negative, but poor (r = -0.2 to -0.4 for various time periods examined). See here for definitions.

Before 2000 the ISM employment data had a weak positive correlation to the BLS data 4 to 7 quarters later (r values above 0.6). Since 2000 the correlations for ISM manufacturing employment as a leading indicator for the BLS manufacturing employment have been between 0 and 0.3 for r (correlation coefficient). These values define correlations as none to poor.

In other words, ISM employment index is not useful in understanding manufacturing jobs growth.

The ISM employment index appears useful in predicting turning points which can lead the BLS data up to one year.