As we reported last month the ISM Manufacturing report continues to show that the recent peak in economic expansion has come to a screeching halt without further support from the Federal Reserve’s endless checkbook. Today’s reading was one of the largest drops on record as the index plunged from 60.4 last month to 53.5 this month.
“Monthly growth slowed very significantly in the manufacturing sector during May, according to the Institute For Supply Management whose headline composite dropped 6.9 points to a much lower-than-expected 53.5. Importantly, new orders slowed a very significant 10.7 points to 51.0, still over 50 to indicate growth compared to April but well under April to indicate a much slower rate of growth. Manufacturers drew heavily on backlog orders which fell 10.5 points to 50.5.
Other readings show a significant slowing in production, a moderate slowing in hiring, and decreasing delays in delivery times that are consistent with slowing conditions. Inventories interestingly contracted in the month, suggesting that manufacturers were quick to keep levels down given slowing demand. It also perhaps reflects supply shortages tied to Japan.”
The mainstream economists were quick to point out that the drop, while surprisingly unexpected, was still above 50 showing that the economy is still expanding. As we have pointed out MANY times in the past – if I was speeding in my car while traveling too close behind the car in front of me; when I slam on my brakes there will be an instant where I am slowing while still traveling forward. Of course, that forward motion stops when I smash into the back of the vehicle in front of me. The same is true for the economy. The direction of the movement is far more important than the number itself and just because the economy hasn’t slammed into a new recession yet… doesn’t mean it can’t.
Furthermore, the current plunge is extremely steep showing that the contraction is much more aggressive than a gradual slowing in the economy. In fact, the last time you had this type of correction was, surprise, when the first round of Quantitative Easing (QE) ended in May of 2010. The only thing that turned the index back up was the implementation of QE 2 that came in September of 2010. Currently, the index is plunging even though QE is still in place until the end of June… it is only a guess what will happen next, but, I have an inclination that it won’t be good.
I have overlaid the ISM index along with its Year Over Year (YOY) percentage change against the YOY change in the S&P 500. As you can see there is a very strong correlation between the expansion and contraction of the manufacturing sector to the markets itself. Looking back at May of 2010 again, where QE ended the first time, and not only do you witness a sharp decline in the ISM index but a 20% decline in the S&P 500.
Weakness in the index was widespread through the entire index and Friday’s NON-Manufacturing index will confirm the weakness. Look for a very weak jobs report as well on Friday.