The ISM non-manufacturing, or Services, survey improved to 50.5 in January from 49.8 in December. This was slightly lower than the consensus expectations for a reading of 51.0.
Once again, the ISM data is showing that the Service side of the economy is much weaker than the Manufacturing side. The Service sector is far larger than the Manufacturing sector, but the Service sector survey does not have the same sort of long-term history that the Manufacturing survey has. The table below comes from the ISM report and compares the two surveys.
Each overall index is comprised of ten sub-indexes, most of which are the same between the two reports. In both reports, a reading over 50 indicates that the sector is expanding and a reading below 50 indicates contraction.
While the Service index moved from contraction to expansion in January, both readings are close enough to the breakeven point that the best interpretation for both months is that the sector is dead in the water — neither expanding nor contracting. While this was the second month in a row that the Service index has risen, it has been hovering close to the 50 line since September.
In the Service report, four of the sub-indexes showed improvement in January, four showed deterioration and two were unchanged. In the Manufacturing report, nine showed improvement and only one deteriorated. In the Manufacturing report, eight of the ten indexes were above the magic 50 mark and only two were below. The Service index has five showing expansion and five showing contraction.
Business Activity Index
The most important of the sub-indexes with respect to current activity is the Business Activity index, which is analogous to the Production index for the Manufacturing report. It is firmly in the expansion camp with a 52.2 reading, but the expansion is showing signs of deceleration as the sub-index fell a full point from 53.3 in December. In contrast, the Production index on the Manufacturing side is showing an absolute boom with a reading or 66.2 — up 6.5 points on the month.
The graph below shows the manufacturing production index and the service production index over the last decade. Unfortunately, the St. Louis Fed has not yet updated its site for the latest Service side number. Note that there is a tendency for the Manufacturing side (red line) to lead the Service side (blue line), but the Service index does not have a particularly long history, so it is sort of hard to say just how good a leading indicator the Manufacturing side is of the Service side.
The most important forward looking measure in the report is the New Orders index. There the news was unambiguously good with that sub-index rising 2.7 points to 54.7. That is not nearly as good as the new order data for Manufacturing (65.9), but still indicates solid expansion.
However, another indicator of future activity, the current backlog of orders, was headed in the wrong direction on the Service side, falling 2.5 points to a quite concretionary 45.5%. Order backlogs in Manufacturing, on the other hand, are swelling with a 6.0 point rise to 56.0.
Jobs Are Key
The thing that is on the top of everyone’s minds right now, though, is jobs. There, the data is mixed in this report. The employment sub-index increased by a full point, but it only reached 44.6, which is well on the concretionary side of things. On the Manufacturing side, the ISM data showed solid improvement, with a 3.1 point gain to 53.3.
However, in the ADP (ADP) employment report released this morning, it showed gains in Service sector jobs and job losses in Manufacturing (although the smallest level of job losses there since January 2008). We will see on Friday which one of these data points, ISM or ADP, is pointing in the right direction.
The one area that the two ISM surveys are on the same page about is Inventories. However, with the exception of retail, inventories are generally a much smaller part of the balance sheet for service firms than they are for manufacturing firms. Both surveys came in with a reading of 46.5 in January, although they are headed in opposite directions, with the Service index falling 5.0 points and the Manufacturing one rising 3.5 points.
Given that the change in inventories contributed almost 60% of the total growth in GDP in the 4th quarter, inventories are far from insignificant. (Just as an aside, the inventory contribution to GDP is really a “change in the change” sort of number. In the fourth quarter inventories were still contracting, not piling up on shelves — they were just contracting at a much slower rate than they were in the third quarter.)
Both surveys are also seeing prices rise sharply, with the Service sub-index rising 1.6 points to 61.2 and the Manufacturing side leaping 8.5 points to 70.0. So far we have not seen much evidence of inflation in the Producer Price Index — and that data will not be out until the middle of the month — but these readings should be considered an early warning sign on that front.
In general I would consider this to be a mildly disappointing report, particularly after the extremely positive Manufacturing report. Yes, we are seeing expansion in the Service side of the economy, but it is extremely anemic expansion.
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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