U.S. Manufacturing Growth Accelerates

Factory Output Grows for the First Time in 6 Months

U.S. Manufacturing Growth Accelerates
June 25, 2015

Is the American economy finally starting to turn the corner into a real recovery? We now have one more indicator pointing in that direction. The May 2015 Institute for Supply Management (ISM) manufacturing report shows an uptick in manufacturing growth for the first time since October 2014.

The PMI (Purchasing Manager's Index) composite came in at 52.8, beating estimates of 52.0 and topping the April reading of 51.5. Readings over 50 in the PMI indicate expansion in factory output. The PMI composite index has been either shrinking or flat since hitting 57.9 in October 2014, so the turnaround is a welcome change indeed.

Part of the problems of the last six months has been attributed to the difficult winter weather and the labor dispute with West Coast ports, but the strong dollar and slow consumer spending have also served to stall manufacturing growth rates.

How important was it for the PMI to break the sinking trend and stay above 50? To put the value in perspective, since July 2009 there has been only one month with a reading below 50 — November 2012 at 48.9. In other words, we have had manufacturing growth (values over 50) for 69 out of the past 70 months; it just has not been very strong growth on average. The July value represented the breakpoint coming out of the Great Recession beginning in late 2007, during which the index sank to 33.1 in December 2008.

As well as reflecting tangible manufacturing improvements, PMI growth has great psychological value for the markets. It provides guidance on overall economic health, but since it is retrospective, trends are more important than any individual value.

The composite index consolidates multiple index factors, including new orders, inventory, production, deliveries from suppliers, prices paid, backlogs of orders, and employment. Looking at the individual components (which all have similar scales with 50 as the benchmark), the picture is still positive overall but somewhat mixed.

The employment index rose above 50 to 51.7 percent, indicating hiring instead of contraction, which is particularly good news for most Americans. New orders, a forward indicator, had their best reading since December at 55.8. Raw material prices (the prices paid) are still lowering at 49.5, just not at the previous rate (40.5 in April). Raw material inventories and order backlogs are growing while customer inventories are shrinking, setting the conditions for an even greater rate of manufacturing growth — assuming continued demand warrants it.

The concerns on future manufacturing growth are focused on the demand side. Consumers are still refusing to increase spending, defying economist's predictions that the windfall from lower gas prices would be mostly directed back into spending instead of savings or debt payments. Personal consumption expenditures (PCE), or consumer spending as defined by the Bureau of Economic Analysis (BEA) in their reports, remain stubbornly low after a slight uptick in March raised hopes.

On the macro scale, the dollar is remaining willfully strong, which depresses factory outputs by making exports more expensive. The trend has flattened out, with the U.S. Dollar Index (DXY) trading in the 95-96 range as of this writing, down slightly from peaks around 100. Anemic economic strength worldwide should keep the dollar high for some time.

Overall, things look better for American manufacturing. As expressed by Jim O'Sullivan of High Frequency Economics, the figures are "suggesting that weakness in manufacturing is past its peak." We may not be completely out of the woods yet, but at least we can see the edge of the forest from here.

Photo ©iStock.com/Andreas Krone

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