Inventory Cycle Has Run Its Course

The ISM manufacturing index fell much more than expected, but close to what our models were foreshadowing — down 3.5 points, to 56.2 in June, the low-water mark of the year. The number of industries reporting growth fell to 13 from 16 in May and 17 in both March and April. Not yet a hard landing, but not a good direction for the bulls.

The ISM orders component cratered to 58.5 after two readings of 65.7 — still a high level to be sure but the lowest this metric has been since last October. The only segment that managed to eke out a gain was the inventory component — to 45.8 from 45.6. The ratio of orders-to-inventories slid to 1.28 from 1.44 — portending further ISM declines ahead.

Moreover, when the ISM is down over four points in a two-month span, it practically signals that the peak in manufacturing activity has been turned in. The problem is that outside of all the stimulus out of the federal government, this whole recovery has been led by an inventory-induced rebound in manufacturing production. There are no other offsets if industrial activity starts to slow down! Ditto for exports, which slid to 56 from 62, again a low for 2010.

And no wonder the bond market is rallying. Look at the meltdown in the inflation indicators. Backlogs down 2.5 points in June, to 57. Vendor delays down to a six-month low of 57.3 from 61 in May. And, prices paid collapsed from 77.5 to 57 — it hasn’t been that low since last November and before that last July.

-Lunch with Dave, 2 Jul 2010, David Rosenberg

I hope it was a three-martini lunch with Dave because this sounds pretty bleak. Now, I won’t lie to you. This is the scenario I have been predicting for months now.

• Double Dip Recession and the Obama 2011 Budget (February 2010): The long and short is that – come Summer – the inventory cycle’s thrust will have dissipated. And if companies are not hiring by this time and consumer spending is not increasing more robustly, then the state budgets, the strategic defaults and all of the rest of that becomes a serious obstacle. In my view, more likely than not, this will lead to another recession late in 2010 or in 2011. And nothing in the President’s budget changes this outlook.
• The mindset will not change; a depressionary relapse may be coming (March 2010): the inventory cycle’s impact on GDP growth will attenuate. By the second half of 2010, inventories will not add considerably to GDP.
• US GDP growth rate is unsustainable; recovery will fade (April 2010): The inventory cycle is already starting to fade. That means weak 1 or 2% growth at best by Q4 2010. Unless job growth picks up tremendously by the second half of the year, this recovery is in trouble.

David Rosenberg says the ISM leads jobs. And, the latest jobs numbers were weak.

I would be non-plussed about the recent ISM data if it weren’t for the column highlighted in red.  Notice how the momentum for everything is slowing.  Not just the overall index, but new orders, production and employment.

Moreover, inventories are going the wrong way: up! Inventories would have a good way to go up, if orders and production stay on the right path. But If everything else continues slowing, the inventory cycle has run its course and the direction of the inventories sub-index will reverse.