Divergent Service Sector Measurements

Big Bounce Back In Non-Manufacturing ISM PMI

As you can see from the chart below, the ISM services PMI rose from 53.7 to 56.4 in August which was a nice bounce back. It ended the index’s 2 month losing streak. This beat estimates for 54 and the high end of the estimate range which was 54.5. This PMI is consistent with 2.7% quarterly GDP growth which is above the consensus for just 2% growth and the projection for 1.8% growth in the ISM manufacturing report. I’m surprised by the strength because the Markit flash services PMI was weak. I don’t think the slowdown is over just because of one strong PMI report.

The services PMI broke from the manufacturing PMI in this report. If you weight services at 80% and manufacturing at 20%, these 2 reports predict 2% to 2.5% yearly GDP growth. That sounds similar to what we have been seeing, but it’s relatively good for this index. It was more bearish in the previous reading obviously since services had a weaker PMI in July. On the other hand, the only times the services new orders index has been this much higher than the manufacturing new orders index in the past 20 years were when the economy was in a recession (2008), or about to go into a recession (2001).

Manufacturing To Be Further Hurt By Global Slowdown

Manufacturing has shrunk as a percentage of the economy, so it might not be as accurate in predicting future economic activity. The last slowdown from 2015-2016 wasn’t indicative of a recession because the weakness was mainly in mining due to the crash in oil prices. This time the weakness is broader based and due to the global economic slowdown and the trade war. If there is a trade deal, the manufacturing sector might bounce back before the rest of the economy weakens enough to fall into a recession.

As you can see from the chart below, the manufacturing sector will likely face global economic headwinds in the next few months. Only 13.5% of OECD leading indicators are above 100, meaning most aren’t signaling improvement. I could see a rebound in 2020 because of the monetary stimulus. China’s deleveraging is having a negative impact on global growth. The Chinese economy will help growth less than it did earlier in the cycle. The good news is historically, by the time this percentage gets this low, stocks actually do well. It must be because there is less room to fall. One problem I see is the S&P 500 isn’t down from when this index peaked. America outperformed in 2018 and some of 2019. It’s now seeing the weakness other countries have dealt with for a while. Therefore, stocks might not do well in the coming months.

Details Of August NMI

The headline index tells you the details of the ISM PMI were mostly good. This isn’t like durable goods orders report which has its headline number manipulated by aircraft orders. The production index was up 8.4 points to 61.5. The new orders index was up 6.2 to 60.3. This drove the divergence from the manufacturing new orders index that I mentioned earlier. The employment reading fell 3.1 to 53.1. That differs from the ADP report. It actually ended up being more accurate than the ADP report as the BLS reading showed disappointing private sector job creation. Just like in the manufacturing PMI, the inventories index was up. It increased 5 points to 55. Obviously, in the services PMI unlike in manufacturing there isn’t a problem with the ratio of new orders to inventories.

The prices index was up 1.7 points to 58.2. As you can see from the chart below, in both ISM PMIs, the 3 month average of the “net commodities up in price” is giving a negative reading. This is the 3rd such period which makes sense because this is the 3rd slowdown (I’m counting the double dip in 2015-2016 as one). The yearly change in CPI isn’t as weak. Maybe that means more disinflation is coming. The major counter to commodities price weakness is service sector inflation catalyzed by wage growth which is caused by the relatively tight labor market. Even the services PMI employment reading was above 50 which means employment is still improving.

Like in the Markit report, which I will get to next, backlogs were worked off. This index fell from 53.5 to 49. Even in the strong ISM services report, the new export orders index fell because of the trade war. It declined from 53.5 to 50.5. The imports index mirrored that reading and its decline. 3 of the 9 quotes in this report mentioned tariffs. This sector hasn’t been feeling the same impact from the trade war as manufacturing, but that should change with the latest round of tariffs in September, October, and December. An accommodation and food services firm stated, “Tariffs are affecting the cost of goods on all items imported from China. We’ve experienced a 10-percent increase on Chinese ingredients which kicked in on August 1.”

Very Weak Markit PMI

As the chart below shows, the Markit services PMI differed from the ISM PMI. It fell from 53 to 50.7 which is the lowest reading since March 2016. The new orders and the composite indexes also fell to their lowest levels since then. The service sector weakness caused the August composite PMI to be consistent with just 1% GDP growth. If you include the stronger July reading, the estimate is for 1.5% GDP growth which is still lower than the consensus of 2%.

The details of this report were bad all around. New export orders fell at the quickest rate in 3 years. Prices paid fell at the fastest rate ever and prices received fell the quickest since October 2009. Expectations for the next year were the lowest ever. The employment reading was the weakest since February 2010. That’s similar to the low employment growth seen in the BLS report year to date. Finally, the rate of backlog depletion was the sharpest since June 2016. 

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