Manufacturing ISM

Because of how remarkable the manufacturing ISM report was there were many extra analytical charts created which I didn’t get to. Let’s look at some more analysis of the manufacturing economy before moving on to the news of Wednesday which was the ISM non-manufacturing report which many consider more important because the services sector hires more workers than the manufacturing sector.

The chart below breaks down the various parts of the ISM report. The goal of this chart is to show how the fastest growing segments are all ones which have been impacted by the hurricanes. Slowing supplier deliveries, paying higher prices, and higher inventories all moved above 100% of their 8 month average because of the hurricanes. The excessive customer inventory being at 44% of the prior 8 month average shows how the transportation delays caused by the hurricanes impacted inventories. This isn’t to say the reason for the great headline report was the hurricanes. The headline number is created by 5 indexes. The top two indexes which effected the headline result in September were new orders and supplier deliveries. It doesn’t seem like there was a big impact from the hurricanes on those portions of the report. Since this was a 13 year high, it’s probable that the index will fall next month. That doesn’t prove this report was only caused by hurricanes. That being said, the report probably was overly optimistic.

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In a previous article we discussed how the industrial production still wasn’t at its late 2014 high. That’s a sharp difference from the ISM PMI because it’s a fixed index. It will never get above the low 60s. The industrial production index grows in every cycle. The fact that it hasn’t grow this cycle is further evidence that this cycle hasn’t been great for manufacturing. To support the thesis that the ISM PMI isn’t an accurate depicter of the manufacturing economy we have a chart which compares it to the Markit PMI. As you can see, there was a sharp divergence in 2010 and there is currently another one. The Markit PMI for September was 53.1 which was a slight increase from 52.8 last month. It’s not at its 1 year high let alone a 13 year high. New order growth softened, employment expanded at the fastest rate in 9 months, and input prices increased at the fastest rate since December 2012.

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The Markit analysis is showing the same information as the ISM report except for new orders. That’s the sticking point. The truth on how new orders are doing tells us how the manufacturing industry is doing. The hard data for September will give us a better idea of the truth. I tend to trust Markit more because it’s tough to believe manufacturing is at a 13 year high. GDP growth forecasts would be higher than 2% if we were at a 13 year high. It could be the ISM data had skewed results from its survey. Markit showed output growth was unchanged from August which at a 14-month low. The expectation for future output growth fell to a 4 month low. It’s possible the actual manufacturing economy is between both reports, but closer to what Markit has.

Non-Manufacturing ISM

The non-manufacturing ISM report exploded higher just like the manufacturing report as the headline report was 59.8%. This is the best report since August 2005 and the third highest print ever for the ISM services index. The expectations were for 55.4 making this a 5 sigma beat. This report is consistent with GDP growth of 4.2%. This shows how this report may be too optimistic as no estimates show Q3 GDP growing that fast. The table below reviews the breakdown of the results. As you can see, it looks just like the manufacturing report as almost every part of the report is growing faster than last month. The increase in prices and inventory being too high are both results from the hurricanes.

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The chart below gives you a historical perspective of the ISM prices and supplier deliveries index. The chart shows what happened during superstorm Sandy which occurred in 2012 and hurricane Katrine in 2005. The ISM supplier deliveries and prices increased before plummeting in previous post-storm economies. I expect the same thing to happen later this year. I’m not implying that there will be economic weakness as a result of these storms; I’m just saying how the makeup of the reports will change.

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Now let’s look at the quotes shown in the ISM services report. A professional, scientific, and technical services firm said, "Hurricane Harvey has been a disruption to normal business activity in the oil and gas industry. Refineries and petrochemical plants were shut down due to the storm, as were many offices along the Gulf Coast. Business is just now returning to some sense of normalcy." This quote explains the temporary expansion of the divide between WTI and Brent crude prices after hurricane Harvey. Most of the other quotes taken were positive, mentioning the storms as temporary hiccups.

Let’s review the Markit report for services. This sector report also showed less enthusiasm than the ISM one. The Markit Activity index was 55.3 which was down from 56.0 in August. There was robust expansion in business activity, an upturn in new businesses, and strengthening inflationary pressures. The output index fell to 54.8 from 55.3 in August. Overall, the service sector was resilient as this report was relatively strong in the face of the storms. The report is consistent with slightly above 2% annualized GDP growth. That’s closer to the forecasts than what the ISM is saying.

Conclusion

The hurricanes effected results. The toughest aspect of these reports isn’t figuring out what the hurricanes did to them; it’s figuring out how overly optimistic the ISM reports are. Given the fact that no GDP forecasts expect +4% growth in Q3 it’s safe to assume they are significantly too optimism. This is a relatively normal occurrence that happens in some of these surveys because they aren’t perfect.