The June headline Manufacturing Purchasing Managers Index reading of 50.9 was a little better than the consensus expectation of 50.5. No biggie. Anything over 50 signals expansion. This is a seasonally adjusted number (see Why Seasonal Adjustment sucks), and it includes eleven subindexes which muddy the water of what the composite number actually means.
To get a clearer picture of the manufacturing economy I track the not seasonally adjusted (NSA) ISM Manufacturing New Orders index. It rose from 44.9 in May, which was the worst level since 2009, to 49.4, which is almost neutral but because it’s below 50, still signals contraction (See Note 1 below).
Note 1: 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 the US Department of Commerce supplies each year in advance. Each year, all of the data SA is benchmarked and restated. In January the ISM issued a restatement of all the Manufacturing and Non Manufacturing indexes since 2009, making the previously reported headline numbers reported for each month essentially garbage.
To get an idea of how good or bad the actual, not seasonally adjusted number is, I compare it to the same month in past years. On the chart, a line connecting the same month each year helps to show the trend.
The June reading was up 4.5 points from May. June has no apparent seasonality, alternating between monthly increases and decreases versus May over the previous 10 years. June’s average month to month change over the previous 10 years was -0.1. This year’s June gain was very strong, but it reversed a big drop in May. Looking at the trend on the chart, this looks like a potential reversal of the two year downtrend, but it will depend on follow through in July and August.
The correlation of this indicator with stock prices is poor. The market has shown that it can go on its merry way for years even as US manufacturing slowly disappears.
The manufacturing sector represents about 12% of the economy. The ISM manufacturing new orders index isn’t even a very good indicator of the overall US economy.
The ISM Non Manufacturing (Services) New Orders Index correlates reasonably well with the overall US economy, but like the manufacturing gauge, isn’t very useful as an indicator of stock market. June’s reading of 50.2 was slightly positive, indicating weak expansion. This isn’t exactly supportive of ebullient US stock prices, but if you’ve followed my reports for any length of time, by now you’ve gotten used to the idea that stock prices measure liquidity, not corporate profits or the performance of the US economy.
The headline number for the non-manufacturing index for June was 52.2, a positive reading signaling expansion, but below the economic consensus of 54. While services are by far the largest sector of the US economy, this number typically is not a market mover.
As with the manufacturing data, my focus here is on the not seasonally adjusted (actual) index of new orders. The June reading of 50.2 was down from 53.1 in May.
Again, there’s a lack of evidence of seasonality in the actual raw survey data. June has had both ups and downs versus May. This year’s drop of 2.9 compared with an average index drop for the past 10 years of -0.5. As opposed to the better than average pickup in the manufacturing sector, new orders for services fell more than typical. The non manufacturing sector is much larger than the manufacturing sector, so this would have a greater weight in overall economic activity.
The negative divergence between this index and stock prices may be a long term warning sign, but negative divergences persisted for 4 years before the markets topped out in 2007. Therefore, like the ISM Manufacturing index, this indicator cannot be used for market timing purposes. The strong performance of stocks versus these indicators suggests that the Fed is driving equity prices to levels which can only be sustained by continued money printing. The economy is not responding in kind and probably does not have self sustaining momentum without the Fed providing artificial stimulus and the US continuing to deficit spend.
And no, the fecal cliff secastration hasn’t hurt the US economy. The spending cuts and tax increases were large enough to reduce the deficit and reduce Treasury supply, which was bullish for stocks because made more Fedbucks available for the stock market. They were not large enough to push the mammoth, slow moving US economy off its recent track. Policy tinkering is meaningless given the size and momentum of the economy, and all the constant gnashing of teeth about policy is a sideshow that traders and investors should ignore.
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