ISM: Is this the mother of all inventory corrections?
The June 2009 Manufacturing ISM Report On Business® came out today and we saw yet another rise in the PMI to 44.8. While equity markets in the U.S. seemed pretty pleased that the numbers continue to go up, I found this report a bit troubling. Let me tell you why.
Back on January 2nd, we saw the ISM at a 28-year low of 32.4. With 50 as the break even between contraction and expansion, 32.4 was showing a deep, deep recession for the manufacturing sector. Since then, things have picked up considerably. In fact the ISM data indicates that the overall economy is growing for the second month in a row – and at a faster rate.
But what bothers me is the uneven picture painted by the areas highlighted in red. They point to an increase in production which is no longer predicated on growth in new orders. In short, we may be seeing a huge inventory restocking huge slowdown in the inventory purge – and that’s it. Notice how new orders are now contracting. Yet, inventories are considered too low. That has caused the manufacturing sector to crank up production to the point where production is now growing.
Translation: manufacturing and production are now adding to GDP instead of subtracting from it. This is something I certainly anticipated (see my post “Third quarter auto production to be significant boost to U.S. GDP”). However, it looks more like this increase in production is merely a response to the low level of inventories. Until we see new orders firmly above 50 on this survey, you should be sceptical as to the sustainability of any increases in production.
According to the ISM, the following is reflective of what survey respondents are saying:
- “Customer inventory burn is complete and real demand has reappeared.” (Machinery)
- “… a lot of people are requoting old business and using favorable pricing to negotiate with their current suppliers.” (Computer & Electronic Products)
- “Banks are reluctant to lend to businesses, and until this changes the economy will continue to be weak.” (Fabricated Metal Products)
- “Slow June, but firm large orders in July, August and September.” (Food, Beverage & Tobacco Products)
- “Market appears to have bottomed out as aftermarket has picked up slightly over the past month.” (Transportation Equipment)
Based on this, one would surmise that production is ready to ramp up to meet new demand. All that is needed is more available credit. However, we will need to see new orders confirm this in the third quarter or this will wind up as the mother of inventory corrections and nothing more.
ISM Manufacturing Survey – Institute for Supply Management