The Institute for Supply Management’s Non-Manufacturing, or Service, survey rose in February to 59.7 from 59.4 in January. Like its venerable brother the Manufacturing survey, this is a “magic 50” index where any reading above 50 indicates that the economy is expanding and anything below 50 represents an economic contraction.
Thus, this means that the Service side of the economy, which is far larger than the Manufacturing side, is not only growing, but the rate of growth accelerated in February relative to January. This is the sixth straight month of acceleration in the overall index, and makes it 15 straight months that it has been over the “magic 50” level. The number came in better than the 59.0 consensus expectation.
Like the Manufacturing survey, this index is made up of ten sub-indexes that roughly correspond to the manufacturing sub indexes. In this recovery, the Manufacturing side of the economy has been stronger than the Service side. That is still the case, as the Manufacturing index (released on Tuesday) rose to 61.4. However, it looks like both sides of the economy are doing very well based on the ISM data.
Results by Sub-Index
Six of the sub-indexes increased and three fell on the service side this month. One was unchanged. All are above the “magic 50” level. The performance of the more important sub-indexes were mixed, but mostly positive. The most important measure of current business activity is, well, the business activity sub-index. It rose 2.3 points this month, reaching the very robust level of 66.9.
Thirteen industries reported higher business activity and just four reported a slowdown in activity. The most important index for the very short-term future is the backlog of orders index. That rose by 1.5 points to 52.0. There were seven industries reporting an increase in backlog, and two with a decline.
As businesses work off their existing backlog of orders, they need to replace them with new orders. There the news is not quite as good, with a fall of 0.5 points to 64.4. That still indicates that new orders are rising at a very healthy clip, just not quite as fast as last month.
There were eleven industries reporting higher new orders and three reporting declines. It thus appears that business activity is picking up, and that the activity will be sustainable since they are getting enough new orders that their order backlog is growing, not just being consumed by the current high activity.
Employment Sub-Index
The employment sub-index is also very important. The 1.1 point increase is encouraging, as it rose to 55.6. That is still well below the manufacturing employment sub-index level of 64.5 (the highest level since 1973!).
Nine industries reported higher employment while five reported trimming payrolls. In yesterday’s ADP report, though, the vast bulk of the job creation appeared to be coming from the Service side, not Manufacturing. Manufacturing only accounted for 20,000 of the 217,000 total jobs added, according to ADP.
Then again, there is a much smaller base of manufacturing jobs, just 10.7% of the total, and the ADP numbers imply they were 9.2% of the total increase in January, so perhaps I’m making too much of the discrepancy. However, just six industries reported an increase in payrolls and eight reported a decline. I suppose it will be up to the BLS report on Friday to “break the tie.”
The employment sub-index has been above the “magic 50” level for six straight months now. One thing to keep in mind is that these are diffusion indexes (the reading is the number of positive responses, plus one half of negative responses). As such, they measure the number of companies that are adding or trimming jobs, not the number of jobs they are creating or losing. Thus it is not exactly an apples-to-apples comparison.
Still, over time, the ISM employment indexes, both manufacturing and non-manufacturing, have tended to track employment well. The graph below shows the history of the key sub-indexes. Unfortunately the St. Louis Fed has not yet updated its FRED database, so the numbers are only through January, but the graph does show the longer-term picture.
“Good,” Bordering on “Great”
Overall, this was a good, bordering on great report. It is highly unlikely that the economy will slip back into a double-dip recession if the ISM Service index and the Manufacturing index are both not only above the 50 mark, but with one above 60 and the other knocking on the door of 60.
As the report was above expectations, the stock market should like it. The acceleration in growth is very welcome. The business activity index is at its highest level since December 2004. The new orders index at its highest level since January of 2004. The employment sub-index is at its highest level since May of 2006.
The Non-Manufacturing index does not have the same sort of long history as does the Manufacturing index, but the level of the ISM Manufacturing index is consistent with an economic boom in the making. Paul Krugman (from this article) last month produced this graph between the quarterly average of the manufacturing PMI and the rate of economic growth (the PMI manufacturing data goes way back, so those quarters of 15%+ economic growth are actually from the 1930’s). While the fit is far from perfect, it is pretty solid.
Plugging the numbers in the regression would predict economic growth of 6.33% (using the average of January and February manufacturing PMI) in the first quarter if the PMI were to hold where it is for March. While I’m not sure that the data from the 1930’s and 40’s that went into that calculation is still relevant, so I would not want to base my economic forecast only on the PMI data. Still, it is very strong, and it looks like it is being confirmed by the Non-Manufacturing data as well.
The table below comes from the ISM report and shows the sub-indexes for the Service index, as well as the corresponding sub-indexes on the Manufacturing side.
