Hidden Weakness in the ISM Index

The Institute for Supply Management's November purchasing managers survey met expectations but contains worrisome elements. In particular, the employment component fell to its lowest level since September 2003, a year in which job growth averaged just 9,000 a month.

In addition, the order backlog component matched its lowest level since January 2002, indicating that companies are building up spare capacity, a harbinger of potential weakness in hiring and capital spending. These data do not calm worries rooted in the recent trend in jobless claims and consumer confidence; concerns should appropriately grow.

The ISM's overall manufacturing index was a respectable 50.8 in November, a level consistent historically with the economy growing at a pace of 2.8%, according to the ISM. That is a pace that would please most in the current environment. Worrisome was the employment component, which fell to 47.8 from 52.0 in October, falling two-tenths of a percentage point below its 20-year average and exhibiting a trend that could be indicative of economic recession, although it is still about 13 points above levels seen during the past two recessions. Still, it is the trend that should stir alarm.

The index on order backlogs is also worrisome. It fell to an anemic 41.5 from 46.0 in October, 8.7 points below its 20-year average. Decreases in order backlogs reduce the need to add new capacity, which could translate into reductions in hiring and capital spending.

Helping to offset weakness in domestic demand continues to be strength in new export orders. The ISM's index on new export orders increased to 58.5 from 57.0 in October to its highest level since May. To underscore the boost that exports have provided to the manufacturing sector, note that U.S. exports in 2007 will be about $500 billion more than five years ago.

With the release of these data, the set of indicators indicating weakening labor demand has grown. Included among these are jobless claims, consumer confidence, industrial production, online job advertising and tax receipts. If these data are confirmed by weakness in upcoming employment statistics, prospects for Fed rate cuts will begin to play a much smaller role in the performance of the financial markets, with fears of economic recession paramount.

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Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of the revised investment classic, The Money Market, first published in 1978 by Marcia Stigum, and The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click here to send him an email.

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