The February headline seasonally adjusted aggregate Manufacturing Purchasing Managers Index reading of 54.2 was substantially better than the consensus expectation of 52. It was the second straight month that economists significantly underestimated this index. Apparently they don’t pay attention to real time economic indicators like withholding tax collections and unemployment claims, both of which have been been going gangbusters, especially considering the increase in tax rates.
To get a feel for the manufacturing economy as represented by this index I track the not seasonally adjusted ISM Manufacturing New Orders index. It rose from 53.1 in January to 55.3 in February. (See Why Seasonal Adjustment sucks). That was the second straight strong monthly gain.
The ISM reports only the seasonally adjusted data. To derive the actual data we need to divide the reported data by the SA factors applied, which are established by the US Department of Commerce each year in advance. Later, all of the data SA is rebenchmarked and restated. In January the ISM just issued a restatement of all the Manufacturing and Non Manufacturing indexes since 2009, making the previously reported headline numbers for each month essentially garbage.
In order to get an idea of how good or bad the actual, not seasonally adjusted number is for February it’s necessary to compare it to February in past years. February was a down month in 10 of the past 10 years. This year the index rose by 2.2. That’s right, this is the first February gain in 11 years. The February average month to month change over the previous 10 years was -5.8. Last year the reading was -5.9 and in 2011 it was -5.4.
There was a similar “anomaly” in January. It too was up, while in 9 of the prior 10 years January was down. With two winter month gains in a row, it begins to look less like a one off, and more like the start of something. I don’t think it’s a coincidence Fed QE cash started pouring into the system in mid November when the Fed began settling forward MBS purchases from September. Than in January it added Treasury purchases, pouring $130 billion gross into the accounts of Primary Dealers, who then disseminated that cash throughout the system. Stocks perked up in November and December and manufacturing followed in January.
This month’s increase broke what had been a downtrend. Last month the index was 3.4 points lower than in January 2012. This month it is 4.6 points higher than where it was in February 2012. It has bounced back from a low reading of 46.9 in June 2012.
That was the same level the index had reached in March 2007, which was 7 months before that bull market ended. While it is now 8 months past the low reading of 2012, it’s impossible to say how long a lead time the indicator may have, if any, before the next bear market. There’s no cause and effect relationship here.
This index trended lower from late 2003 to 2007, while stock prices continued to rise. That was a potential hint that the stock market may have been in a bubble beginning in 2005, since it kept rising while ISM’s new orders were slowing. At the time, the Fed was growing its balance sheet steadily at the rate of 5% per year.
The Fed stopped that in May 2007, bringing the growth rate of the System Open Market Account (SOMA) to zero at that time. The ISM new orders index briefly went negative in early 2007, but then recovered until October. That was when the Fed pulled the plug on the System Open Market Account transferring its funds to the TAF, the first of its alphabet soup emergency direct lending programs. At the same time, the Fed abruptly shut down open market operations, which had essentially been the only conduit for the transmission of monetary policy for decades. That froze out the Primary Dealers and broke the monetary transmission mechanisms for getting cash from the Fed into the markets and the economy that had worked since the late 1930s. The ISM index next went negative in January 2008, by which time the market was down for the count.
The Fed had stopped putting cash into the system in 2007 as the divergence between ISM New Orders and the market progressed. Today the Fed is adding cash at a breakneck pace, using the old tried and true conduit of open market operations with the Primary Dealers. That makes a huge difference. The markets and the economic data both move in response to money printing or lack thereof. The Primary Dealers efficiently take wholesale funds from the Fed and move them into the banking system where ultimately some of it makes it to the economy.
So does inflation, but it may be hiding in places other than the CPI, such as housing inflation, which has renewed with a vengeance. To the Fed, that’s a good thing. Rising stock prices are also a measure of asset inflation, which to the Fed is an especially good thing, whereas in reality both housing and stock price gains may really represent financial market distortion and missallocation of capital due to the interest rate subsidy the Fed gives these markets. Meanwhile, a small portion of that Fed cash does “trickle out” into economic activity as businesses read the stock tables for signals to whether order more stuff or not.
The ISM manufacturing new orders index is usually a good leading indicator of economic activity, but it is not very useful as a stock market indicator in terms of its year to year trends. Both it and the markets follow the Fed.
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