The ISM Manufacturing PMI for May came in at 53.5, a modest decrease of 1.3 points from April’s reading of 54.8. While still signaling positive growth (50 is the Mendoza line between expansion and contraction), the report confirmed the expectations of a softening in U.S. economic activity in the second quarter of the year. The overall index is a good coincident indicator, meaning that it accurately tells us how fast the U.S. manufacturing sector is currently growing, but a poor leading indicator, meaning that it doesn’t tell us much about future growth.
The overall index, however, is the result of multiple components (e.g. employment, production, prices, etc.), some of which actually seem to lead the overall index by a few months. In particular, some of our independent researchers found that the spread between the new orders component and the inventories component tends to lead the overall index by three months (the spread is simply the difference between the two components at any point in time). This result was later confirmed by our proprietary research, which found the relationship to be statistically significant at the 99.9% level over a sample going back to 1949. The rationale behind this result is simple: New orders need to be filled, while inventories need to be replenished. Therefore more new orders and lower inventories today will require more work in the near future, and vice versa.
While the overall ISM manufacturing suffered a slight decline in May, the new orders component saw the third consecutive increase at the same time as the inventories component experienced its third consecutive decrease. This bodes well for overall U.S. manufacturing activity in the upcoming months. More precisely, these two leading components are suggesting we shall see some consolidation in June, followed by a sharp rebound going into the summer.