Purchasing Managers' Index head fake

The Institute of Supply Management (ISM) reported their Purchasing Managers' Index (PMI) for September that was better than expected. The September PMI of 51.5 was 1.9 points better than the August print of 49.6. The Street had been looking for a 49.7 September print. The September PMI was up mainly due to an improvement in new orders, which increased 5.2 points to 52.3.

MANUFACTURING AT A GLANCE SEPTEMBER 2012
Index	Series Index Sep	Series Index Aug	Percentage Point Change	Direction	Rate of Change	Trend* (Months)
PMI™	51.5	49.6	+1.9	Growing	From Contracting	1
New Orders	52.3	47.1	+5.2	Growing	From Contracting	1
Production	49.5	47.2	+2.3	Contracting	Slower	2
Employment	54.7	51.6	+3.1	Growing	Faster	36
Supplier Deliveries	50.3	49.3	+1.0	Slowing	From Faster	1
Inventories	50.5	53.0	-2.5	Growing	Slower	2
Customers' Inventories	49.5	49.0	+0.5	Too Low	Slower	10
Prices	58.0	54.0	+4.0	Increasing	Faster	2
Backlog of Orders	44.0	42.5	+1.5	Contracting	Slower	6
Exports	48.5	47.0	+1.5	Contracting	Slower	4
Imports	49.5	49.0	+0.5	Contracting	Slower	2
OVERALL ECONOMY				Growing	Faster	40
Manufacturing Sector				Growing	From Contracting	1

This is a head fake and in my mind the improvement will not hold. I am holding my hat on the customer inventories index, which ticked up to 49.5 in September from 49 in August. This index typically runs inverse to the new orders index and should be looked at in reverse versus the other PMI measures, i.e. a low (high) number is a positive (negative). A high reading in the customer inventories index suggests that - without any corresponding increase in demand- that the channel manufacturers are selling in to is, to exaggerate, stuffed.

Looking back at history, the customer inventory index has averaged around 45. We have only seen 11 instances since 1997 when the new orders index ticked up in conjunction with the customer inventories while the customer inventories index was above 49. Two of those have occurred in the last three months. Excluding these data points, because of a lack of forward data, there have been only 3 instances when the PMI showed on uptick six months hence, or 33% positive PMI outcomes. Moreover, the central tendency for the PMI in the six months following the before mentioned setup is for a 2 point decline.

More worrisome is that the average and median PMI is held up by one data point, the six month forward results that occurred following the March 2009 PMI results, where the PMI rallied 18 points. I liken this to the fact that March 2009 corresponded with the bottom of the economic cycle, the ensuing snap-back in demand, and euphoria surrounding QE1, all of which are unlikely to be repeated. Excluding this data point, the PMI showed an average decline of more than 4 points. I would look for the PMI to, at best, muddle around the breakeven line over the next few months with a negative bias.