Expect Manufacturing Economy to Moderate

Last Friday, the Institute of Supply Management released the results of their latest purchasing managers index survey, which indicated that the manufacturing economy once again expanded. The PMI rounded out the month at 56.4, 0.2 points better than in September, largely due to a significant increase inventories. The survey results for October are show below.

MANUFACTURING AT A GLANCE OCTOBER 2013
Index	Series Index Oct	Series Index Sep	Percentage Point Change	Direction	Rate of Change	Trend* (Months)
PMI™	56.4	56.2	+0.2	Growing	Faster	5
New Orders	60.6	60.5	+0.1	Growing	Faster	5
Production	60.8	62.6	-1.8	Growing	Slower	5
Employment	53.2	55.4	-2.2	Growing	Slower	4
Supplier Deliveries	54.7	52.6	+2.1	Slowing	Faster	4
Inventories	52.5	50.0	+2.5	Growing	From Unchanged	1
Customers' Inventories	47.0	43.0	+4.0	Too Low	Slower	23
Prices	55.5	56.5	-1.0	Increasing	Slower	3
Backlog of Orders	51.5	49.5	+2.0	Growing	From Contracting	1
Exports	57.0	52.0	+5.0	Growing	Faster	11
Imports	55.5	55.0	+0.5	Growing	Faster	9
OVERALL ECONOMY				Growing	Faster	53
Manufacturing Sector				Growing	Faster	5

*Number of months moving in current direction.

As I indicated above, the latest PMI results show that manufacturing activity continues to expand in the US. I would also note that many of internal components, most notably new orders and production were strong, continuing a three month trend. That said, the increase in the inventory measure sticks out like a sore thumb and I think it suggests that manufacturing activity will likely wane in the coming months.

Since the PMI's inception, an inventory demarcation above 50 has more often than not been associated with a falling PMI in the 3 to 6 months following this observation. In fact, the average/median PMI falls by around 4 points in the 6-months following a high inventory reading. For comparisons sake, the average 6-month change in the PMI for any period since 1948 is roughly zero.

Thinking about the business dynamics here, this only makes sense, as new orders can be filled via existing inventories, which results in manufacturers pulling back on production. This would not be a problem if new order rates continued to climb strongly. However, I am of the opinion that new order rates will likely moderate in the coming months. First off, the new order index has remained at or above 60 for three months now and history suggests that the rate of growth in orders will tail off after such strong successive measures. And actually, the average/median decline in the new order index is on the order of 7 points following similarly strong periods. More so, the customer inventories index is back to average levels, suggesting that an inventory restock becomes increasingly unlikely. And remember, the economy continues to just muddle along.

You should not be surprised to see a pull back in the PMI in future periods.