The Institute for Supply Management’s non-manufacturing, or service, sector rose to 55.4 in March, up 2.4 points from February, and was above consensus expectations of a 54.0 reading.

This is the third straight month that the index has been above the magic 50.0 level which separates expansion from contraction. Services are lagging well behind the manufacturing index which was reported on Thursday at a reading of 59.6, up 3.1 points and also well above expectations (see ISM Reaches 6-Year High).

The service sector is much larger than the manufacturing sector, accounting for over five times as many jobs. However, the ISM service index does not have the long history that the manufacturing survey does. The current configuration of it only goes back to the start of 2008. Thus, the fact that this is the highest the overall index has ever hit is not all that significant. However, the fact that it is up from a reading of 41.2 a year ago and a low of 37.2 in November of 2008 is very significant.

Like the manufacturing index, the non-manufacturing index is made up of ten sub-indexes which roughly parallel the ones used in the manufacturing survey. The table below shows the comparisons. In March, eight of the ten sub-indexes improved from February, and seven were above the magic 50 mark.

Business Activity Index
 
The most important of the sub-indexes as a measure of current conditions is the business activity index, which is roughly analogous to the manufacturing production index. It rose to 60.0, up 5.2 points. The percentage of companies reporting higher activity rose to 37% from 23% in February, while the number reporting lower activity fell to 13% from 20%. That is almost as strong as the 61.1 increase in the manufacturing production index, and a much bigger monthly increase.

If the business activity index is the one that tells the most about the present, the most important indicator of the future is the new orders index. It surged 7.3 points to 62.3, and has been above 50 now for 7 straight months. Firms reporting higher new orders rose to 37% from 23%, while those reporting falling new orders dropped to 14% from 18%.

The rise in new orders meant that the higher level of business activity has not eaten into the backlog of orders for most firms. The order backlog index rose to 55.5 from 46.0, a rise of 10.5 points. The percentage of firms reporting higher backlogs more than doubled to 22% from 10%, while the number of firms reporting declines in their backlogs dropped to 11% from 18%.

More Numbers Below the Headline

The employment sub-index seems to be a bit at odds with the BLS employment data. It has consistently been much weaker than the manufacturing sub-index for employment, yet the BLS reported a much bigger increase in private sector service jobs than in manufacturing jobs, (see Employment Report In-Depth and More Breakdown of BLS Numbers) and the ADP report last Wednesday also reported growth in service jobs and shrinkage in manufacturing jobs.

The service employment sub-index is still below 50.0, indicating a contraction in employment, but at 49.8, its pretty much at the neutral mark, and the sub-index did rise 1.2 points on the month. The number of firms reporting higher employment rose to 16% from 12%, while the number reporting lower employment fell to 19% from 20%. Of course it is possible that the firms reporting higher employment were increasing workers by the hundreds, while those reporting lower employment only shed a handful of workers, so one set of data does not have to be “wrong” if it conflicts with the other.

Inventories are still contracting, but at a slower rate, as the index rose to 46.5% from 45.0%. However, the inventory sentiment index dropped to 52.5 from 60.0, indicating that most of the respondents still thought their inventories were too high, although less so than last month.

New export orders surged by 10.5 points to 57.5 as the percentage reporting higher export orders rose to 21% from 15% while the percentage reporting a drop in export orders fell to 6% from 21%. The import index also rose to 51.0 from 48.5, mostly due to a drop in firms reporting lower imports to 9% from 14%.

However, most of the firms surveyed don’t keep separate track of their imports. Still, taken together the two readings indicate an increase in world trade, and possibly a drop in the trade deficit going forward, both of which would be very good things. But given the large number of firms that don’t really have much to say on the import side, the numbers are suggestive, not predicative.

The ISM lists the industries that are doing well and poorly for each sub-index. The one industry that stands out in terms of weakness across many of the sub-indexes is Real Estate rental and leasing. This is not good news for the publically traded REITs such as Vornado Realty Trust (VNO) and Boston Properties (BXP), but is not a surprise given the overall weakness in Commercial Real Estate.

On the other hand, over the long term, the weak commercial real estate market will allow those with the financial resources to do so to pick up properties at more attractive prices. So for the real estate companies it is a case of short-term pain, and perhaps long-term gain. So far, the stock market has been willing to look over the valley for those stocks.

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.

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