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The ISM Non-Manufacturing Report: Six Causes for Concern

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And why this is one report you should keep on your radar.

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The ISM Non-Manufacturing Report on Business is a data point that very few people pay attention to. However, as I've pointed out in several previous articles, I think it's well worth keeping this report on one's radar. This is for two reasons: First, the vast majority of US private production is in the service sector. Second, the vast majority of the US economy is based on private consumption, and the vast majority of that consumption is directed towards the consumption of services.

Thus, the ISM Non-Manufacturing Report can provide us with clues about the sentiment of on-the-ground business managers that are administering the bulk of the US economy. And this report can also provide various clues about the strength of US consumers that spend the lion's share of their income on services.

The ISM Non-Manufacturing Report for November breaks a multi-month string of improving data going back to mid 2009.

Of note are the following readings:

1. The overall NMI reading of 49.6 indicates contraction and was at lower levels than those registered in both October and September.

2. The Business Activity Index contracted sharply from 55.2 in October to the current reading of 49.6. This level is similar to those registered in mid 2009.

3. The New Orders Index showed an easing of momentum, although it's still signaling expansion.

4. The Backlog of Orders Index reading at 48.5 indicates a contraction of backlogs which is disappointing after two straight months of expansion in October and September.

5. The Employment Index continued to contract. Perhaps more worrying, the rate of contraction indicated is even greater than that registered in August and September of 2009. This index has contracted in 22 of the last 23 months.

6. Inventories continue to contract, as indicated by the 45.5 reading in the Inventories Index for November. However, contrary to all of the speculation about a potential boost to GDP from inventory rebuilding, the Inventory Sentiment Index reading of 61.5 shows that purchasing managers believe that inventories are still too high.

On the whole, there's significant internal consistency in the report between the sentiment readings and the activity readings. Unfortunately, virtually all signs in November pointed to an ebb in economic momentum. For example, the belief exhibited by purchasing managers that inventories are still too high is well supported by the fact that business activity and backlogs of orders -- both of which are objective measures -- are contracting.

It would be premature to say whether the November ISM-NMI represents an early warning sign of a petering out of economic momentum or whether it's simply a small glitch in a steady uptrend. It's important to recall that uptrends don't manifest in strait lines. However, in our search for clues about which direction the US economy is ultimately heading, I believe one would be well-served to keep the information contained in this ISM-NMI report in mind as other data are released regarding the health of the service-oriented, consumer-driven US economy.

I remain 100% cash.

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No positions in stocks mentioned.
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