The Institute for Supply Management’s survey of manufacturing purchasing managers was stronger than expected in December, coming in at 55.9 — up from 53.6 in November and better than the consensus expectations for a rise to 54.3. The ISM index is constructed from 10 sub-indexes and is set so 50 is the dividing line between the economy expanding and contracting.

This is the 5th straight month that the overall index has been in positive (over 50) territory.  In January of 2009, it was all the way down at 35.6. Seven of the 10 sub-indexes saw improvement, and eight of the ten are at of above the 50 mark. The only two that are below the mark are the ones that deal with inventories, and low inventories provide a potential snapback effect for the economy.

Key Sub-Indexes

The most forward-looking of the sub-indexes is the one for new orders, which rose 5.2 points to 65.5 from 60.3 in November. This is the 6th straight month that the new orders index has been above the 50 level.  Most of the improvement in the index in December came from fewer firms seeing a decline in new orders rather than from a surge of firms that were reporting higher new orders.

The production sub-index is probably the most important gauge of what is happening now. It rose to 61.8 from 59.9, a gain of 1.9 points, and marks the 7th straight month where the production index has been above 50. The employment index was positive for the third month in a row, which is a good omen for the employment report that is due out on Friday.

However, in November, the index was at 50.8 and the BLS still reported a decline in manufacturing jobs in November. In December it rose to 52.0, a gain of 1.2 points. We will see if that translates into higher actual new manufacturing jobs on Friday morning.

There are two sub-indexes which deal with inventories: one for the firms being surveyed, and the second dealing with their assessments of their customer’s inventory levels. Their own inventory levels are still going down, but are doing so at a slower rate, with an index reading of 43.4 vs. 41.3 in November.

This is the 44th straight month (almost 4 years!) that inventories have been contracting. Customer inventories have not been shriking as long, only 9 straight months, but they are contracting much faster.  The customer inventory index reading was just 35.0 down from 37.0 in November.

Inflation Entering the Discussion?

Prices, on the other hand, are rising with an index reading of 61.5 — a big 6.5 point jump from 55.0 in November. I think there is still enough slack in the economy that inflation should not be a problem in the near term, but numbers like that make me a bit nervous about it.

The backlog or orders index was also a little disconcerting. It fell to 50.0, a neutral reading from 52.0 in November. Yes, firms are getting new orders, but they are able to work them off right away, and thus they are not building up the backlog. New export orders are still expanding but at a slower rate, with a reading of 54.5 vs. 56.0 in November.

On the other hand, imports of materials rose with a reading of 55.0 vs. 51.5 in November. The combination of these two could indicate that we are going to see some deterioration in the net export numbers in the months to come.

Apparel Looking Good, Wood Products Soften

I consider the three most important of the three sub-indexes to be New Orders, Production and Employment.  One industry that is listed as being most positive in all three of these is Apparel, which probably means that there are some good things going on at firms like VF Corp (VFC) and Polo Ralph Lauren (RF).

On the other hand the wood products industry was listed as near the worst on all three of those indexes.  This means that things might be getting softer for the likes of International Paper (IP) and Weyerhaeuser (WY).

Overall, it was a very strong and encouraging report, and gets the new year off on the right foot when it comes to economic data.

Read the full analyst report on “VFC”
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Read the full analyst report on “IP”
Read the full analyst report on “WY”
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