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Investing Specialists

A Pressure Cooker in the Economy?

With employment and inventory cut to the bone, there could be some scrambling in the manufacturing sector amid a recovery.

The manufacturing sector showed strong signs of life for the month of May, based on data from the Institute of Supply Management. Manufacturing along with construction have been by far the worst-performing sectors this recession, so it was particularly pleasing to see such a sharp improvement.

The ISM Composite Index for manufacturing improved from 41.1 to 42.7 between April and May. The index has been up every month since December 2008, when the index bottomed at 23.7. Generally an extended reading above 41.2 is consistent with growth in GDP. The complete survey (not the index) shows data on nine categories ranging from new orders to backlogs and pricing. Seven of the nine categories showed improvement in May, with employment basically flat and inventories down. Although counted as a negative in the index, we view declining inventories at this point in the cycle as creating long-term growth potential as businesses are forced to restock inventories that are too low.

The new orders component of the ISM report was particularly positive, increasing to 51.1 in May from 47.2 in April. This statistic indicates that companies reporting an increase in orders exceeded companies reporting a decline in orders. This is the first month in the last 17 that this index has been above 50%. Just as importantly, nine of 18 industry sub-groups showed improving order trends, so the trend appears to be broadly based. The new orders component of the ISM index typically leads an economic recovery by just over four months. Given that the index bottomed in December, the economy could have bottomed as early as May based on this metric.