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October 2014 ISM

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October continued the trend whereby the manufacturing sector registers significantly faster growth than the overall economy. The Purchasing Manager’s Index (PMI) for October, released this morning, reflects the renaissance in U.S-based manufacturing as the following comments provided by the Institute for Supply Management suggest:

The past relationship between the PMI® and the overall economy indicates that the average PMI® for January through October (55.6 percent) corresponds to a 4.1 percent increase in real gross domestic product (GDP) on an annualized basis. In addition, if the PMI® for October (59 percent) is annualized, it corresponds to a 5.2 percent increase in real GDP annually.

The implied GDP growth rates are well above the 3% GDP rate likely to be registered for the year. The break from the past relationships between growth in the manufacturing sector and the overall economy leads to the conclusion that we are experiencing something which has not occurred in quite some time; namely, the manufacturing sector as a source of strength for the domestic economy. Technology-enabled new productivity tools within the sector are driving a revolution of sorts. And, remarkably, this is occurring within the context of a sluggish global backdrop, a generally weak domestic construction market, and a fragile business “psyche” on behalf of most businesses.

As the leading indicator (new orders) of the PMI report suggests (2nd line in table below), the trend continues to have some legs beneath it.

Granted, it is important to remember that the October PMI readings are “red-hot”, and some backtracking in new orders and the overall PMI are likely ahead. However, this does not mean the economic expansion is long-in-the-tooth or that the Fed’s current path away from its long-standing zero-interest-rate policy will prove to be an expansion killer. Economic expansions become vulnerable as unsustainable excesses—typically in the form of private sector debt accumulation and rising inflation—render the expansion brittle.

At present, we are a long way from such conditions. (Support for this conclusion comes from another indicator that’s registering a major break from its past trend—the domestic saving rate. It is rising– hardly an omen of unsustainable consumer spending.)

From an investment perspective, we are also very likely a long way from the next recession in corporate earnings and conditions typically associated with a “bear market” in stock prices. Meanwhile, the generally slow economic backdrop only adds to the pressure on companies to achieve both productivity gains and bring innovative new products and services to market rapidly and cost effectively. The manufacturing renaissance is ready and able to respond.

NOTE: All figures except backlog of orders, customer inventories, imports, exports, inventories & prices paid are seasonally adjusted. The diffusion index is calculated by adding the percent of positive responses plus one half of those responding the same.

* A PMI™ reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally declining. A PMI™ in excess of 42.2 percent, over a period of time, indicates that the overall economy, or gross domestic product (GDP), is generally expanding; below 42.2 percent, it is generally declining.

The information contained in this report is based on sources believed to be reliable, but we do not guarantee its accuracy or completeness. The information is published for informational purposes and does not constitute an offer, solicitation, or recommendation of an investment or advisory services.