ISM Manufacturing Production Index Improves The 2nd Most In 20 Years

Much Improved ISM PMI

January manufacturing ISM PMI was 50.9. That was up from the revised 47.8 (from 47.2) in December and beat estimates for 48.7. It beat the highest estimate which was 50. It was expected to come near 49.5, so it wasn't far off. It's surprising there weren’t higher estimates Especially since regional Fed data implied the ISM PMI would hit 56. 

Finally, the ISM report came closer to matching the Markit and regional Fed data. In this manufacturing slowdown, the ISM data has been the worst. It’s still 1 point below the Markit PMI. This was a great report on a sequential basis and a mediocre one on an absolute basis.

As you can see from the chart below, the 3.1 point increase was the biggest monthly spike since July 2013. This was the highest reading since July which was the last one above 50. However, this latest PMI was only 0.1 above the 1-year average and is in the 34th percentile since 1950. 

Being towards the low end is actually good news for stocks. It’s better to have a low PMI than a high one because markets anticipate cycle changes. It’s also good to see an increase because markets have priced in a turnaround. Without a turnaround, some of the gains might be given back even though a below 50 PMI is usually good news for stock returns.

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Details Of The ISM Report

Within this report, 4 of 6 big industries showed growth (up from 2) and 6 of the 10 sub-indexes were above 50. This overall PMI is consistent with 2.4% GDP growth. That would be slightly above Q4’s 2.1% growth. However, it could be representative of a sharp lift higher if the underlying numbers are better. I expect inventory investment to hurt GDP less and imports to help it less. 

If net trade, inventories, and government spending normalize, the headline growth rate will be more representative of how the economy did. If not, the market should ignore those one-time factors and focus on real final sales growth anyway. The market ignored the weak Q4 reading because it expected a turnaround in 2020.

This was a great report because every sub-index rose except inventories. New orders went from contracting to increasing as the index increased 4.4 points to 52. Production index exploded higher by 9.5 pouts to 54.3. On a percentage basis, this was the 2nd best gain since 2000. 

Employment index rose 1.4 to 46.6 which still signals a contraction. Some bears have been cherry-picking this sub-index, saying it means job creation will be weak. I don’t buy into that because manufacturing is a small part of the labor market. Consensus for January job creation is 158,000 jobs. Estimate for manufacturing job creation is -6,000. Market and economists know not to expect manufacturing to carry the load for job creation.

Tariffs & Trade (ISM)

With Phase 1 of the trade deal in place, new export orders increased 6 points to 53.3 and imports rose from 48.8 to 51.3. The backlogs index rose 2.4 to 45.7. Even though wage growth has been weakening and commodities prices have been collapsing, the prices index was up 1.6 to 53.3. Bloomberg total commodities index is down 9.47% year to date. We have no commodities inflation. 

Even with the trade deal with China in place, 2 firms complained about tariffs. That’s fair because the trade deal did nothing to lower tariffs. A plastics and rubber products firm stated, “Tariffs on injection molds will impact selection of mold builder for future jobs. We are more likely to choose domestic rather than offshore.” It’s no surprise a petroleum and coal products firm was negative as oil prices have cratered. The firm stated, “Our customer slowdown has not reached the bottom.”

December Factory Orders

November factor orders report was revised to show a 1.2% monthly decline instead of a 0.7% decline. However, the December report showed a 1.8% increase which beat estimates for 1.3% growth. Goal is to get back to positive business investment growth. Core business orders fell 0.8%. The chart below shows the quarterly rolling average of non-defense capital goods orders excluding aircrafts growth appears to be bottoming. 

Monthly ex-transportation orders rose 0.6% after rising 0.2%. Ex-defense orders fell 0.6% after rising 0.1%. Shipments growth improved from 0.5% to 0.3%. Durable goods orders growth stayed at 2.4% compared to the recent durable goods orders report. To be clear, this factory orders report is a completion of the durable goods report. It adds more numbers and revises the reported numbers.

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Retail Sales Growth Should Be Good

All indications are January retail sales growth will improve from December which was modestly weak. Motor vehicles and parts part of the retail sales report drove it down last month. That shouldn’t be as much of the case in this upcoming report as total vehicle sales rose from 16.6 million to 16.8 million which met estimates. Domestic vehicle sales rose from 13 million to 13.1 million.

Furthermore, Redbook sales growth has been solid. Latest reading for the week of February includes the last week of January. Yearly same-store sales growth rose from 5.5% to 5.7%. As you can see from the chart below, the IBD/TIPP economic optimism index increased to 59.8 in February which was the highest since January 2004. 

Coronavirus outbreak had no impact on consumer sentiment. This index was from the last week of January. It implies the University of Michigan consumer sentiment index will improve in February to potentially a cycle high.

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Conclusion

ISM manufacturing index got back above 50. Many knew this would happen at some point in 1H 2020. It occurred slightly earlier than expected. Personally, I expect positive yearly industrial production growth at some point this quarter. 

A decline in oil might ruin that as mining production should weaken. The consumer is very confident and vehicle sales improved slightly. This data implies yearly retail sales growth will improve in January.