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December 2013 ISM

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With new orders rising to the highest level of 2013, the manufacturing renaissance will continue into 2014 (and beyond). As a good leading indicator of the overall economy, confidence in the resiliency of the economic expansion should continue to deepen in the New Year. In the ISM’s own words:

The past relationship between the PMI™ and the overall economy indicates that the average PMI™ for January through December (53.9 percent) corresponds to a 3.7 percent increase in real gross domestic product (GDP) on an annualized basis. In addition, if the PMI™ for December (57 percent) is annualized, it corresponds to a 4.6 percent increase in real GDP annually.

The inventory components of today’s report are highlighted in the table below. One of the (latest) concerns about the economy was the reported excessive build in inventories as reflected in previously released GDP data for the 3rd quarter. Today’s ISM suggests that any inventory excesses that did exist have been worked down at year end.

As an economic expansion ages, excesses in inventories, credit creation and inflation accumulate which render an expansion brittle. The expansion typically ends when the Fed moves to combat inflation by significantly raising the short-term interest rates under its control. An inverted yield curve (long rates below short rates) almost always precedes recessions.

At 50+ months of age the current economic expansion already exceeds the 33 month average age of U.S. expansions. Yet do not fret. With few (if any) excesses, a yield curve that is super steep and far from inverted, growth that will likely still track along a slow path in the face of Washington’s wet blanket policies, and where so many still fear a repeat of 2008 financial panic conditions, this expansion is still young at heart.

Yes, this cycle will end with excesses and a corporate earnings crunching recession. But such conditions are likely some time off (as in years).

In the meantime, the economy should be supportive of the corporate earnings cycle, and low inflation should be favorable for stock valuations and returns. It won’t be a straight line up for stocks of course, and worries about the Fed raising rates will create anxiety along the way. But the new year has the promise to be another happy one for stock investors (though another difficult one for bond investors).

Jan. 3 (FactSet) — Following is a summary of U.S. manufacturing conditions from the Institute for Supply Management (ISM).

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.