Today the Institute of Supply Management released their monthly Non-Manufacturing index. Today’s release was a complete reversal of last week’s increase in the manufacturing index as the index pointed to a drop from 52.9 in October to 52 in November. While the number does still indicate expansion in the “services” side of the regional survey the trend has been slowing for the last several months.
One thing to note here is that also released today was the New Factory Orders report which showed a sharp contraction from September’s positive 0.3% print to a negative 0.4% reading for October. Importantly, both orders for durables goods, down 0.5%, and orders for non-durable goods, down 0.3% percent, showed weakness in the overall sector which may portend to much weaker data coming in the months ahead.
Back to the Non-Manufacturing Index we also saw a slowing in the buildup of unfilled orders which slowed to 0.2% versus 0.6% and 0.9% gains in the prior two months. As opposed to the media’s hype about the strength of the consumer the slowing of unfilled orders combined with the decline in new orders will hold down future shipments. Another possible alarm in today’s report is a big build in inventories of 0.9%. High inventories, together with soft orders, will limit demand for inventory replenishment.
Furthermore, there was a large drop in the employment index which fell 4.4 points to a sub-50 level of 48.9 to indicate a decline in the size of the ISM sample’s workforce. The drop in employment follows is a reflection of the soft new orders reading in October with new orders in November rising only slightly to 53.0. It will be interesting to see the how unemployment plays out going into the new year as the temporary retail hires that are pushing employment for November and December begin to receive their pink slips in the 1st quarter. With order backlogs soft which will limit future business activity there will be real pressure on maintaining current employment levels particularly if the economy slows any and begins to threaten profit margins.
With the release we are able to update our ISM Composite index. There are several very key takeaways from the index as it stands today:
- The composite index ticked up to 52.4 in November of 2011 from 51.9 in the previous month.
- We saw this same event occur when the ISM Composite index ticked up to 53.8 in November of 2007 from 53.1 in the previous month. The recession started in December of 2007.
- While no recession has been identified as of yet the sharp decline in the index from its peak of 64.2 in February of this year should be cause for worry.
- The first sub-50 reading of the ISM Composite index didn’t occur until January of 2008 at 46.6. The ISM Composite Index did not collapse and stay below 50 until August of 2008.
- The current level of the composite index is lower than previous to the last recession showing overall weakness in the production and services side of the economy.
- The drag in unfilled orders, new orders, inventories and employment, as noted above, don’t bode well for continued strength in the coming months.
Lastly, the stock market as a function tends to lag declines in the composite index. With the market advancing into the end of the year as the composite index wanes the similarities to the months leading up to the last recession are eerily similar. Remaining defensive, while contrary to the “risk on” mentality at the current time, seems to be the more prudent stance given the many variables at play. Higher cash levels, income generation through dividends and interest, and portfolio hedges continue to be allocation strategy of choice at the moment.