ISM Non-Manufacturing Index - Not Adding Up
"Things that make you go ... hmmm" as the line from Saturday Night Live goes which really fits in nicely with today's ISM Non-Manufacturing release. The index declined to 52.9 in October from 53 in September, which is the lowest level for the index since July. However, there is something questionable going on here. Let's take a look at the readings from the 3rd quarter of this year: July 52.7, August 53.3 and September 53.0. There's the problem. This is the non-manufacturing index that is a reading of the consumer. The behavior of this index brings into real question that massive jump in 3rd quarter GDP at 2.5% from 1.3%, which is a 92% increase, a jump that is largely attributable on the resurgence of personal consumption expenditures that we discussed.
However, if consumers were out spending like "drunken sailors" why didn't it show up in the non-manufacturing index? It should have but it didn't. Furthermore, one of the areas that should have seen large increases would be "new orders". That didn't happen either. New orders slowed to 52.4 from September's 56.5, which is lower than they were in August during the supposed spending boom. Backlog orders moved to a monthly contraction at a sub-50 reading of 47.0, which means that suppliers are working through backlogs as new orders dry up. This doesn't bode well for employment in the months ahead if this trend doesn't reverse.
Furthermore, our ISM Composite Index, a weighted average of both the Manufacturing and Non-Manufacturing Indexes, is at levels seen just before the last recession. Most concerning is the angle of descent in the composite index, which has fallen sharply since the beginning of this year. While the market has gained some traction in recent weeks, it is also worth noting that there is a high correlation between the ISM Composite Index and the market itself. This is not surprising since the composite index is a function of the very things that drive consumers and businesses and ultimately their profitability.
With consumer confidence at some of the lowest levels on record, both current and future expectations, and the reality that the bulk of the spending this summer came from consumer's trying to cover skyrocketing utility bills due to a massive nationwide heat wave, the reality is that weakness will be showing up in the final quarter of the year. Maybe this is why the Fed lowered their guidance across the board yesterday.
Going forward the market is likely to struggle as the economy comes to grips with the reality of the consumer. Furthermore, the seriousness of a Greek default is being underestimated as the likelihood of such an event is growing. This has serious implications from the trigger of credit default swap events that will impact the markets and the banks. Furthermore, the resulting sharp decline in economic growth in Greece will trigger more default issues and have a ripple effect through the rest of the Eurozone, which is already on the brink of recession. With the Eurozone comprising 20% of our exports, a recessionary drag from Europe will consequently drag us into recession as well.
This is why we are still recommending an overweight exposure to fixed income and cash as a protection against market volatility. Caution is advised until more clarity can be found. In the meantime, I will sit here, think and go "hmmmm...."