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09/26/2010

The week ahead closes September.

 

Since the credit crisis began in the 3rd Quarter of 2008, the first business day of each calendar month has been a highly anticipated day for me. That is the day that the U.S. ISM Manufacturing Index is released at 10am EST. The ISM has been an excellent leading indicator to gauge the direction of the capital markets. On Friday October 1, I expect the same - an extremely important data release that will be the highlight of the week. Let's preview it:

 

The ISM experienced a historic decline in late 2008 into early 2009 (figure 1 below).

 

The capital markets' 2009 recovery was telegraphed by the ISM in April 2009 (figure 2 below).

 

One year later, in April 2010, a recovery peak was established at 60.4. Since April, a softening in the ISM has correlated with a Baseball Season of Frustration for the equity market.

 

Last month's ISM surprised the market with a 56.3 reading versus the previous month's 55.5. The expectation was for continued softening toward the expansion / contraction line at 50. I believe the ISM rebound set the tone for the favorable equity price action in September. So, the critical question for Friday is: was last month's rebound a one-off or has the soft patch found a trough?

 

Analysts' expectations suggest a one-off; the consensus figure is 54.0. In fact, there is concern that the ISM could begin to trend lower below 50 into the first quarter of 2011.

 

Why the concern? Let's go inside the numbers and identify what to watch for. The most relevant internal for ISM is the gap between new orders and inventories.

 

A shrinking in the gap suggests a decline in the manufacturing growth rate. That is where the concern comes from and what investors need to watch for this Friday - NEW ORDERS INDEX and INVENTORIES. Although the headline ISM last month surprised higher, the "gap" did in fact shrink. Take a look:

 

 

                     Aug.  July  June   May April March  Feb.  Jan.  Dec.  6-mo

                     2010  2010  2010  2010  2010  2010  2010  2010  2009   Avg

================================================================================

Composite Index      51.5  54.3  53.8  55.4  55.4  55.4  53.0  50.5  49.8   54.3

--------------------------------------------------------------------------------

Business Activity    54.4  57.4  58.1  61.1  60.3  60.0  54.8  52.2  53.2   58.6

Prices Paid          60.3  52.7  53.8  60.6  64.7  62.9  60.4  61.2  59.6   59.2

New Orders           52.4  56.7  54.4  57.1  58.2  62.3  55.0  54.7  52.0   56.9

Backlog of Orders *  50.5  52.0  55.5  56.0  49.5  55.5  46.0  45.5  48.0   53.2

Supplier Deliveries* 51.0  52.0  53.0  53.0  53.5  49.5  53.5  50.5  50.5   52.0

Inventory Change *   53.5  55.5  58.5  62.5  54.5  46.5  45.0  46.5  51.5   55.2

Inventory Sentiment* 60.0  59.0  59.0  60.5  53.5  52.5  60.0  64.5  61.0   57.4

Employment           48.2  50.9  49.7  50.4  49.5  49.8  48.6  44.6  43.6   49.8

New Export Orders *  46.5  52.0  48.0  53.5  57.0  57.5  47.0  46.0  46.0   52.4

Imports*             50.5  48.0  48.0  56.5  56.5  51.0  48.5  47.0  52.5   51.8

================================================================================

                     Aug.  July  June   May April March  Feb.  Jan.  Dec.  6-mo

                     2010  2010  2010  2010  2010  2010  2010  2010  2009   Avg

================================================================================

Manufacturing & Non-Manufacturing

Composite ISM Index  52.1  54.4  54.1  55.9  56.0  55.9  53.4  51.4  50.4   54.7

 

 

CONCLUSION: Last week's surprise jump in durable goods orders suggests that business investment is not softening as much as feared. I am not convinced that the ISM will trend lower below 50 into the first quarter of 2011. Keep in mind, if it did break below 50, that does not suggest an imminent double dip as the chart of 1991 (figure 3 below) reflects. What further ISM softening will signal is that during its two day meeting November 2 and November 3, the FOMC will reintroduce asset purchases of $1 trillion dollars to expand the Fed's balance sheet from its current $2 trillion level. For investors, as suggested by the price of Gold, the question becomes, is your portfolio inflation protected?

 

FIGURE 1 U.S. ISM 9/30/04 to 8/31/10

 


Source: Bloomberg

 

 

FIGURE 2 U.S. ISM 7/31/08 to 8/31/10

 


Source: Bloomberg

 

FIGURE 3 U.S. ISM 1991 RECESSION

 


Source: Bloomberg

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