Saturday, December 02, 2006

Implications of the weak ISM manufacturing report for the overall economy

The markets and commentators reacted rather negatively to the weak ISM manufacturing report. Yes, it did show a contraction after years of expansion, but only very modestly (49.5 relative to a stable 50.0) and most likely simply reflecting weakness in housing and automobiles. We must also make the standard disclaimer that a one-month change in a data series is never an indication of a trend change or even the nature of the trend. The immediate question is what this report means about the overall economy. The report tells us that:

A PMI in excess of 42 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the November PMI indicates that the overall economy is continuing to grow while the manufacturing sector has now entered a period of contraction. "The past relationship between the PMI and the overall economy indicates that the average PMI for January through November (54.1 percent) corresponds to a 4.1 percent increase in real gross domestic product (GDP). In addition, if the PMI for November (49.5 percent) is annualized, it corresponds to a 2.4 percent increase in real GDP annually."

So, manufacturing is still doing well better than the level associated with an overall economic contraction, and roughly indicates a current overall economic growth rate of 2.4%.

Yes, the slowdown of the housing market has had some impact on the overall economy, but not as severe as a number of commentaters have suggested. The impact will likely continue for a short while, but probably not for more than a few months. I still expect that even housing will start showing at least some modest growth by sometime in the spring of 2007. GDP will likely be back up to the 3% growth range in Q2 of 2007.

-- Jack Krupansky

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