The economic slowdown in China is starting to have some effect in the U.S. beyond sending the stock market into periodic convulsions. That's one possible conclusion from the August 2015 manufacturing report of the Institute for Supply Management (ISM).
The ISM PMI, an important leading indicator of economic activity, is a composite index that combines five manufacturing indices: New Orders, Production, Employment, Supplier Deliveries, and Inventories. The PMI fell to 51.1 in August, its lowest reading since May 2013, down from a 52.7 reading in July. (PMI readings above 50 indicate expansion while those below 50 indicate contraction.) The unexpected economic slowdown and lower consumption from China takes most of the blame — China's imports in August fell 14.3%.
New manufacturing orders also fell to their lowest value since May 2013, suffering a drop from 56.5 in July to 51.7 in August. The employment index followed suit, dropping from 52.7 in July to 51.2 in August. Supplier deliveries are slowing, raw material inventories are contracting, and the customer inventories index took a big jump from 44 to 53. All are indicators of slower growth in the manufacturing sector, which constitutes approximately 12% of the economy.
While the slowdown in China's economy is the main concern, the strength of the dollar also plays a role. China's currency devaluation aggravated the problem, but the strength of the dollar against trading partner currencies had been a drag on American exports even before China's recent issues.
Concerns about exports are being partially offset by domestic improvements in demand. Construction spending was particularly bright, with an increase of 13.9%. That's the best year-over-year gain in over nine years. Automobile sales hit a seasonally adjusted 17.8 million in August for the strongest number in ten years.
As a result, not all industries are suffering and some are optimistic about the near future based on their survey comments to the ISM. From one chemical company: "Modest growth slightly ahead of GDP. Optimistic for the remainder of the year as we have little international exposure." Other comments include "Our business is good due to the increase in commercial construction" and "Raw metals price decreases will impact our business favorably."
It is possible that the ISM report could play into the Federal Reserve's decision whether to raise interest rates at their September meeting. It takes some time for the effect of an event like the Chinese slowdown to work its way through the economy as compared to the immediate effects of the stock market, and the Fed may see a potential economic slowdown that could be aggravated by an interest rate hike — even the small one that is expected.
While the ISM report may not have been good news, it is not catastrophic either. August expansion may have been the slowest in two years, but it was still an expansion. According to ISM, August represented the 32nd consecutive month of expansion in the manufacturing sector and the 75th consecutive month of overall economic expansion. The New Orders and Production Indices have also held above 50 for 33 and 36 consecutive months respectively.
Third quarter GDP estimates are still around 2.5% growth — not up to the 3.7% growth of the second quarter but more in line with recent growth rates. Economists are expecting growth to continue at a relatively slow pace, but they are expecting growth all the same, likely keeping the PMI above 50.
Keep the bad news of the PMI report in perspective — many countries would happily trade their economic performance for ours right now.