Global| Jun 02 2020ISM Surveys of Manufacturing: Sharp Contraction Underway & No Sign of Recovery
|in:Viewpoints
Summary
In May, the Institute of Supply Management (ISM) released two surveys on manufacturing. The message is bleak; the contraction in activity remains sharp and firms expect a record decline in revenues and capital expenditures for 2020. [...]
In May, the Institute of Supply Management (ISM) released two surveys on manufacturing. The message is bleak; the contraction in activity remains sharp and firms expect a record decline in revenues and capital expenditures for 2020.
The May composite index for manufacturing rose 1.6 percentage points to 43.1%. The headline reading overstates the activity level in manufacturing. Three key sub-components, new orders, production, and employment, have readings in the low 30s. The low readings on production and jobs speak about the sharp contraction. Pessimism about a recovery is apparent in the low level for new orders.
The ISM manufacturing index was initially created in the early 1980s by Mr. Ted Torda, a colleague of mine at the Office of the Chief Economist at the Department of Commerce. ISM manufacturing index was created to help predict quarterly changes in GDP. The initial launch of the ISM manufacturing index had a weighting scheme of new orders (.3), production (.25), employment (.2), supplier deliveries (.15), and inventories (.1). The current weighting scheme applies equal weights (.2) to the five components.
Using the original weights the May 2020 composite index is estimated at 39.5, up from the 36.9 reading in April. Both readings are about 4 percentage points lower than the published figures.
Why is that important? The ISM composite index is a diffusion index. Both the level and the change in the index level are important. The published figure of 43.1% or the adjusted figure of 39.5% both say the same thing: the manufacturing sector is still contracting.
Yet, the one shortcoming of a diffusion index is that it does not distinguish between the magnitudes of change. That means large declines in one industry could be offset by small increases in another industry and vice versa. Also, declines in activity are not linear any more so than increases. In other words, just because a monthly reading moves up or down from the prior month that has no bearing on the next months reading.
In May, the 30% readings for production, employment and new orders indicate that the manufacturing sector is still experiencing a sharp downturn. And the fact that these readings are marginally above the record lows of April create a false impression that the road to an eventual rebound is just a few months away.
Weakness in the manufacturing sector and pessimism on the outlook is also seen the semi-annual survey of manufacturers. According to the survey results released in mid-May, firms expect overall revenue to decline by 10.3% in 2020. But 58% of those surveyed expecting a crash, with revenues off 20%. Plunging sales have forced firms to plan for record layoffs and to cut capital expenditures by a stunning 19%.
The message from manufacturing is that a severe contraction remains in play and a recovery is a long way off. Both view are at odds with the optimism of the equity markets.
Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
Joseph G. Carson
AuthorMore in Author Profile »Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein. Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees. He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.