Manufacturing Activity Remains Lackluster

Updated from 10:51 a.m. EDT

The U.S. manufacturing sector remained stuck in neutral last month with factory operators reluctant to commit capacity in the face of uncertain demand, a key survey showed.

The Institute for Supply Management's U.S. factory index came in at a disappointing 50.5 in August, unchanged from July and slightly below economists' expectations. While anything over 50 indicates the sector is expanding, the growth is close to negligible and several key components of the index, including new orders, showed contraction.

The report exacerbated a selloff on Wall Street, where the Dow Jones Industrial Average was recently down 249 points at 8414.

The institute's new orders index fell to 49.7, the first contraction in that number since in November 2001. It stood at 50.4 in July. Meanwhile the production index, a gauge of work being performed, fell to 55.6 from 55.7 in July.

Cold Water

On Friday, some economists were moved to upwardly revise their ISM expectation after stronger-than-expected readings in durable goods orders and the Chicago purchasing managers' index.

And while consumer spending -- another area of the economy that has held up well of late -- continued to rise in July, several components of the ISM survey cast doubt on that area's resilience. Of the most immediate concern was a decline in the inventory index to 41.8 from 45.2, a trend that indicates stockpiles are being used up at a slower pace, while prices paid tumbled to 61.5 from 68.3. Backlogs also fell to 45 from 45.5.

Despite the market's reaction, several economists said they didn't review the report as all that bad.

"It's certainly a weak report but it doesn't suggest the economy is collapsing," said Jim O'Sullivan, U.S. economist for UBS Warburg. "It clearly signals a loss of momentum and this keeps the debate open on how much the economy is weakening and should the Federal Reserve step in."

Bond prices rose on the data and federal funds futures were pricing in a roughly 40% chance of an easing at the Federal Open Market Committee's Sept. 24 meeting.

Market Weakness

Stan Shipley, senior economist at Merrill Lynch, said the weak stock market itself is the culprit here. The fact that the markets have been unable to sustain any meaningful gains has created uncertainty among businesses. As a result, they're placing fewer orders and manufacturers are keeping their inventories lean.

"We suspect the stock market uncertainty accounts for that weakness. The ISM will bounce back in October or November. The market may not bounce back, but it won't go down," Shipley said.

Shipley also thinks the August ISM report gives fuel to the argument that the Fed will ease interest rates later this year, a move that could boost the stock market. But Shipley said he is reserving final judgement on the Fed's actions until later this week, after retail sales and employment figures are released.

Bill Cheney, chief economist and John Hancock Financial Services, wasn't as quick to believe the August ISM report builds an argument for the Fed to lower rates.

"It's the same as July. That's not so awful. And it's still above 50. This won't persuade the Fed to do anything one way or the other," Cheney said.

The ISM surveys more than 400 companies in 20 industries, including clothing, printing, transportation, furniture and plastics. Manufacturing accounts for about one-sixth of the economy.