Manufacturing output remains solid in May, reports ISM

May manufacturing activity continued to head in the right direction, according to the Institute for Supply Management's (ISM) Manufacturing Report on Business.

ISM said that PMI, the report's key metric, increased 1.4% in May to 58.7 (a reading of 50 or higher indicates growth). This marks the 21st consecutive month of PMI growth, with the overall economy now having grown for 109 straight months. The May PMI reading is 1.1% even with the 12-month average of 58.7.

ISM said that 16 of the 18 sectors it tracks experienced growth in March, including: Textile Mills; Nonmetallic Mineral Products; Electrical Equipment, Appliances & Components; Printing & Related Support Activities; Fabricated Metal Products; Furniture & Related Products; Machinery; Chemical Products; Food, Beverage & Tobacco Products; Computer & Electronic Products; Petroleum & Coal Products; Plastics & Rubber Products; Miscellaneous Manufacturing; Transportation Equipment; Paper Products; and Primary Metals. It added that no industry reported a decrease in PMI in May compared to April.

The majority of the report's key metrics, including the PMI, were up in May.

New orders, which are commonly referred to as the engine that drives manufacturing, saw a 2.5% increase to 63.7, with new orders now having shown growth for the 29th consecutive month. This increase stopped two months of sequential declines, even though the new orders index for both March and April was above 60, as has been the case for the last 13 months. Fifteen of 18 manufacturing sectors reported new orders growth in May.

May production rose 4.3% to 61.5 and has now grown for the last 21 months while putting a halt to four months of expanding at a slower rate. Employment was up 2.1% to 56.3, growing for 20 straight months and ending two months of slowing expansion, with 13 of 18 reporting sectors indicating employment growth was up. Inventories fell 2.7% to 50.6, growing, albeit at a slower rate for the fifth straight month.

Tim Fiore, chair of the ISM's Manufacturing Business Survey Committee, was upbeat about the report's performance as it relates to current economic conditions.

“Demand has been consistently strong…and it continues to get stronger,” said Fiore. “This is reflected in the new orders number, which was very good, as well as customer inventories, which dropped under 40 (to 39.6) for the first time since 2011. And the backlog of orders number (at 63.5) is the highest number since 2004. Things look good, but the only caution here is what may happen with the trade battles.”

But the real message of the May report, he said, comes on the consumption side in the form of production and employment, which was clear in how each metric reversed softening expansion that occurred in three of the last four months, while contributing a cumulative 6.4 points to the May PMI compared to April.

Even though each metric reversed months of declining expansion, Fiore said it was still not enough to satisfy customer inventory needs or to address all of the input that resulted in increased backlog.

“Overall, there is still lots of runway here for the input side, with the input side being the single biggest constraint to continue PMI expansion,” he said. “If you look at the input side, supplier deliveries (which slowed at a faster rate to 62.0 in May for the 20th straight month) and inventory count declined -1.6. Supplier deliveries has been pretty consistent over the last six months, which is a healthy struggle and not likely to get much worse or better in the short term. But all of that equates to the inventory issue and the fact that it is declining to the point where it is almost contracting, and I think that it will contract next month.”

One reason for the expected decline in inventories has to do with tariff-related impacts, which Fiore said has opened up a hole in the supply orders stream, which is happening and likely to remain intact for most of the summer.

“Back in March, when buyers were faced with rising steel prices, they did not just agree to a 20-25% increase, they had to go to management and argue about it and they probably tripled the time it took to convert it to a purchase order to put a contract in place,” he explained. “And lead time was going from eight weeks to 14 weeks at the same time, so that combination means that we probably have some pretty significant supply gaps that a lot of people are working on to try to fill, and I don't see the U.S. steel market as being very responsive. I think we are going to have a continuing problem with the inventory count, and the supplier delivery number will be in the 60-to-62 range or possibly higher. That will limit the PMI's ability to get much higher.”

When looking at the PMI as a hole, Fiore said what is really making it strong is the trio of new orders, production, and employment.

“Those need to be viewed at the top three of the five main metrics in the PMI,” he said.

With one month left in the second quarter, Fiore said he expects the second quarter PMI to come in ahead of the first quarter's 2.2% growth rate and end up above 3%. He added that ISM is forecasting a 6% annual increase in revenue for 2018.

“As we close the second quarter, we will likely see an artificial constraint on inventories, because nobody wants to close a quarter with a lot of material. I think we will see some type of dip in PMI for June. There are also seasonality factors after that in July and August because of vacations.”

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