ISM Services Index Up - Analyst Blog

The Institute for Supply Management’s non-manufacturing (services) index rose to 50.1 in December from 48.7 in November, effectively saying that the service side of the economy is neither expanding nor contracting (50.0 is the dividing line). This is in marked contrast to the Manufacturing index it released on Monday.

The service side covers far more of the economy than does the manufacturing side, but the service index is much newer and does not have the same sort of predictive history that the manufacturing index does. The table below compares the two indexes, and the sub-indexes that make them up.

Of particular interest is the employment index, which has been contracting now for 20 straight months on the service side, while it has been over 50 now for the last three months on the manufacturing side. This directly contradicts the ADP report that came out this morning that showed that the economy lost 96,000 goods producing jobs in December, including 43,000 in manufacturing, while adding 12,000 service sector jobs. At least the ISM numbers show that service sector employment contracted slower in December than in November, with a reading of 44.0 vs. 41.6.

On the service side, six of the ten sub-indexes showed improvement from November, and four deteriorated. Seven are above the 50 dividing line, and three are still showing contraction. In November, only four of sub-indexes were in positive (above 50) territory.

The biggest area of improvement in the service index was in inventories. However, with the exception of retail, for most service industries, inventories tend to be a very small part of their balance sheets (often just the stuff in the office supply cabinet). It jumped six full points, to 51.5 from 45.5.

The most important sub-index concerning the current state of the service index is the Business Activity Index, which is comparable to the Production index for Manufacturing. It rose above 50 with a 4.1 point gain to 53.7. The decline in that sub-index in November was particularly sharp, and the index is actually below where it was in September and October.

The most important leading indicator of the sub-indexes is the New Orders index. It remains well above 50 at 52.1, but it is showing a much slower rate of expansion than in November, having fallen 3.0 points. The new orders index has now been above the 50 level for 4 straight months. However, most of the new orders are being worked off quickly (through the higher business activity side), and the backlog of orders is both contracting (below 50) and doing so at a faster rate than in November (down 0.5 points).

The import index jumped sharply, up 6.5 points and now into expansion territory at 52.5, while new export orders crashed by 8.5 points falling to 46.0 from 54.5. This seems to indicate to me that the rally the dollar has staged over the last few months is starting to have detrimental effects, and I would not be surprised to see the trade deficit widen again in coming months. Both imports and exports were expanding on the manufacturing side, but export orders were slowing while imports were growing more quickly on the manufacturing side.

There were two industries that stand out as consistently showing the best performance across the sub-indexes: agriculture and retail. The improvements on the agriculture side probably indicate good things for firms like Archer Daniels Midland (ADM) and indirectly for firms like fertilizer supplier Potash Corp (POT). On retail, I would be more inclined still to favor the low end discounters like Family Dollar (FDO) and Big Lots (BIG). However, if you wanted to combine the two trends, you might consider looking at Tractor Supply Co. (TSCO).

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.