Fundamental Analysis

ISM: Manufacturing Sector Continues to Move Forward

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Purchasing managers signaled continued gains in the manufacturing sector. Production, new orders and employment registered expansion. Meanwhile, input cost pressures appear to have increased.

Manufacturing Signals for Continued Strength

The ISM manufacturing index moderated to 56.3 in July from 57.8 in June and thereby remains in expansion mode (top chart). This is a positive sign for industrial production and was the eleventh consecutive month in which the index has been above breakeven. Our outlook is for about 2.5 percent growth for industrial production in the second half of this year.

The production subcomponent dropped to 60.6 from 62.4 in June. Fourteen industries reported growth (including wood products, chemicals and machinery) in production, while only textile mills indicated that production declined last month. For both production and employment, the gains were broad-based.

Employment fell to 55.2 in July from 57.2 in June. Eleven of 18 sectors reported gains in employment including paper, food & beverage, plastics and chemicals.

New Orders—Signal of Growth Ahead

Forward-looking indicators also were strong, suggesting that manufacturing production should continue to expand in coming months. New orders remained at a high level at 60.4 and have been in growth mode for 11 straight months (middle chart). Fourteen of 18 industries showed growth in orders, including plastics, electrical equipment, appliances and chemicals. The gains in new orders are solid and very broad-based.

Foreign sources of demand contributed to the overall strength in orders as the new export orders subcomponent came in at 57.5 in July after an index of 59.5 in June. Eleven industries reported growth in new export orders. The "backlog of orders" subcomponent came in at 55.0 in July, the seventh straight month of expansion. Rising backlogs are another forward indication that manufacturing production will continue ahead.

Cost Pressures Appear to Have Increased

Rising commodity prices earlier this year had led to some cost pressures in the nation's factory sector. This is confirmed by the increase of 7 points to 62 for July's prices paid index (bottom chart). Fourteen of the 18 industries surveyed indicated paying increased prices for their inputs. Paper, furniture, primary metals and food & beverage were among the industries paying higher prices.

Commodities up in price included aluminum (for the ninth straight month), corrugated boxes (five straight months) and electric components. The rise in the ISM prices index does intimate upward pressure on core finished goods in the PPI index. Our outlook is for rising inflation that will prompt the FOMC to start to shrink its balance sheet in the fall and raise the federal funds rate as early as December.

Author: Wells Fargo SecuritiesWebsite: http://www.wellsfargo.com/
Wells Fargo Securities
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