ISM Business Conditions Index

The Institute for Supply Management can hardly be described as a ‘happening’ or ‘fun’ crowd. The entire concept of supply chain management is enough to make most of us yawn with indifference. So it’s very hard to get a crowd wound up over the ISM Monthly Report on Business. But perhaps today is a little exception.

That’s because today’s ISM release is the most tangible piece of evidence so far that the recession is over.

Each month the ISM diligently gathers data from its members. It asks detailed questions about their perceptions of business conditions, and compiles the information across both industries and supply chain process stage. The output is what we would expect from a bunch of industrial engineers: careful, methodical, timely, and excruciatingly dull. Nonetheless through the years the overall index of business conditions has won a central place in the hearts of all of us who follow the economy.

Why?

Because it has provided a very good indicator of where the economy is headed. It is a modestly successful predictive tool.

With that said, and with great fanfare, let it be known that today’s information points to a growing economy. The index now stands at 52.9%. Any reading over the magic 50% mark is associated with growth. This improvement brings the index to its highest level since June 2007, and compares with its cyclical low of 32.9% back in December 2008. Obviously things are headed in the right direction.

More to the point the majority of industries are now talking of growth, and the issues now coming to the fore are related to increasing demand: things such as slower supply deliveries and declining inventories.

Many analysts have been calling this part of our recession a ‘typical’ inventory cycle, and today’s data certainly sustains that view. Inventories have declined for 40 straight months, they did last month as well. This process of meeting sales from inventory, rather than from current production, has left most businesses and manufacturers with very empty shelves. So even a modest increase in demand – and let’s be honest: demand has scarcely moved – has a magnified effect on production. Factories have to swing into gear sometime, and they appear to be starting now.

So this is very encouraging news.

Perhaps the most encouraging single data point is the news that new orders index jumped 9.6% and is now comfortably over the sustainable growth level at 64.9%. So there is no doubt that underlying business conditions have turned upward: the economy has started to grow.

Naturally the news has some darker side to it: the 13 month decline in the ISM employment index is still continuing. There was a modest uptick last month so conditions are not as bad as before, but the employment index remains stuck stubbornly below that 50% level.

We should all treat this news with caution because of all the caveats I have talked about here before. That employment component is worrisome. We need more jobs to get overall demand to grow at anything like a sustainable rate over the medium to long haul.

I know this sounds circular: we need more jobs to get growth, and we need growth to get more jobs. The important point to keep in mind is that we seem to following a very typical path currently. Recessions, and indeed depressions, have a way of ending – they follow a ‘natural’ course – with the depletion of inventories being a sure sign that things are about to restart. Once we scrape the bottom of inventory we have to start production come what may. And that usually feeds into new hiring and a rapid upturn in activity.

The cautionary point at the moment is that the nature of business has changed considerably since that ‘typical’ story line was written. In fact the last couple of recessions have been followed by very shallow employment gains. And even those modest gains came many months after the recovery had begun. I attribute this laggardly performance to much tighter cost control in business, where re-hiring is delayed much longer than before; to a radical change in the mix of the economy, we have much less of our employment in manufacturing than before; and to the effects of globalization, much of the sharply cyclical employment we used to have is now ‘off-shored’, so we don’t experience the immediate benefits of our increased spending.

This combination of factors has dulled the economy’s cyclicality, at least on the upside.

So we remain vulnerable to any potential ‘shock’ that might de-rail us.

But let’s set that aside for a moment and bask in the good news.

The recession is over.

Now we have to wait for confirmation when the GDP numbers come out for the third quarter.