The Institute for Supply Management (ISM) releases monthly reports on the health of the manufacturing and services sectors in the U.S. The reports are based on surveys conducted by the ISM covering a variety of business factors, from new orders to employment. These reports, like all economic reports, are not definitive when it comes to economic forecasting but they tend to be leading indicators (that is, they are among the first data points to change when there is a shift in the pace of economic growth) of the health of the economy, which puts them among the favorites of economists and financial analysts.
The Augusts ISM reports paint a picture of slowing economic growth. The manufacturing index shifted to contraction following five consecutive months of growth. Of note, the new orders index, an indication of manufacturing sales, declined 7.8% from July to August. In addition, the production index, a measure of production activity, declined 5.8% and the backlog of orders index, a measure of orders that have not yet been completed, declined 2.5%. The only positive in the report is the new export orders index, a measure of new sales to foreign countries, which was unchanged.
The ISM services report was not as gloomy as the manufacturing report but still showed a slowing pace of growth. The overall index declined from 55.5 in July to 51.4 in August. A number over 50 represents growth. Therefore, the report shows that the services sector is still growing but at a markedly slower pace than in previous months. Again, the new orders index showed the greatest decline, falling 8.9% from 60.3 in July to 51.4 in August. Unlike the manufacturing report, the new export orders index also declined, falling 9% from a positive reading of 55.5 to a negative reading of 46.5. The business activity/production index fell 7.5% from 59.3 to 51.8 and the backlog of orders index fell 1.5% from 51.0 to 49.5.
Some of this data is not entirely surprising. For example, the decrease in new export orders for the services sector may be due to an increase in the value of the U.S. dollar following the Brexit vote. When the dollar increases in value, it makes US-based travel and other services more expensive for those domiciled outside the U.S. So an increase in the value of the U.S. dollar would be expected to result in slowing export demand.
The decrease in production and employment in the manufacturing sector may be partly explained by the retooling of auto plants. Auto manufacturers regularly shut down their plants for several weeks to retool for the next model year. During this period, the plant’s production is halted and hourly workers are laid off until the plant is brought back online. This can lead to weak production and employment data as auto manufacturing still represents a larger percentage of the nation’s manufacturing activity. But the slowdown is short lived.
The more difficult aspect of both reports to explain is the sharp slowdown in new orders. Many economists use the new orders index as the leading, or predictive, index as it gives some insight into future production activity. When the new orders index increases, the production, employment, and backlog of orders indexes are expected to increase in the future. Likewise, when the new orders index declines, the production, employment, and backlog of orders indexes may be expected to decrease in the future. Therefore, the sharp decline in the new orders in August may be a signal that economic activity and growth for the third quarter will remain slow.