The ISM Fallacy
Yesterday's "blowout" ISM reading of 55.7 (on 53 in consensus) was enough to lead to a big market rally, at least temporarily. Yet, just like CfC and the overall Q3 GDP took early credit for massive stimulus payments (whose cost will be felt more gradually over the next decade), it appears the same principle of "borrowing from the future" is applicable to the ISM reading as well. And if David Rosenberg is correct, and the ISM, along with all other stimulus indicators, holds the seeds of its own destruction inside of it, look for this to be an ISM top, potentially until such time as the next stimulus is invoked.
From his morning piece:
ISM is following a very similar pattern as it did in the aborted 2002 recovery year, again led by a brief spurt of automotive-related growth. What caught our eye in the report was the decline in the new orders–to-inventories ratio — to its lowest level since February (1.25x from 1.43x in September and 1.89x in August). This ratio tends to lead ISM by 3-to-6 months (and recall that it peaked three months ahead of the June 2002 peak in the ISM) and seeing as it peaked in August, it would not surprise us to start seeing the headline index roll over heading into year-end.
From our research, the S&P 500 was already effectively pricing in a 59.0 level in the ISM index, so it will be interesting to see if this data-based rally is any more sustained than what we saw coming out of the better-than-expected GDP report last week. This market still has plenty of “growth” priced in.
In case it is lost Rosie, for one, is not buying the ISM growth argument:
With all deference to the ISM index, the regional surveys have, for the most part, not validated the strong message from the national figure:
1. Boston’s Purchasing Managers’ Index (PMI) fell to 44.9 from 47.5
2. Chicago’s PMI rose to 54.2 from 46.1
3. New York’s PMI index sagged to 60.8 from 72.9
4. Cincinnati’s PMI edged up to 44.6 from 44
5. Milwaukee’s PMI fell to 50 from 58
6. Richmond Fed index down to 7 from 14
7. Kansas City Fed production index slipped to 6 from 16
8. Texas manufacturing index worsened to -14.3 from -6.4
9. The Southeast Michigan business activity index slid to 51.3 from 62.5.
So, seven regions were down; two were up; and somehow the national index ran up 3.1 points to 55.7. Right.
And lastly, some concerns about this mythical inventory restocking, which just happens to be Mr. Liesman's favorite strawman, which however seems set on never occurring.
While the ISM index did suggest that the era of destocking is over, the chart below is the reason why we are sceptical about the inventory cycle. The level of inventories across manufacturing, wholesale and retail relative to aggregate sales is still uncomfortably high, at 1.40x. A steady-state figure consistent with vigorous economic expansion is closer to 1.30x; and note that the last cycle really only took on a sustained head of steam once the I/S ratio broke down towards 1.35x.
And as for Buffett's "bet on America" and growing inventories, by buying Burlington Northern, one wonders just how much of a risky bet this is when one considers that the source of the financing likely will come from taxpayer subsidized Citi and BofA. The government is now playing some pretty serious shell games, using an iconic and not-disinterested figurehead (what is Buffett's downside if the market tanks again?) to channel optimism (not the first time Buffett has done so), while providing virtually free, taxpayer provided funding. It does, however, beg the question of why the BNI board took all of 15 minutes to hit Mr. Buffett's bid. We will provide details of the BNI transaction as we get them.