Economic Commentary
Daniel Laufenberg, Ph.D.

Numerous economic data series are released between the publication dates of the Laufenberg Economic Quarterly (LEQ). These commentaries are designed to provide insight on the more recent data and their implications for the economic outlook.


Interpreting the ISM manufacturing index and the employment situation report for May
(June 4, 2011)

Financial market participants are increasingly concerned about the fate of the current economic expansion in the U.S. Of course, there is still a surprisingly large segment of the population that believes the economy is still in a recession. An unemployment rate at 9.1 percent certainly gives them reason to be pessimistic. But once again, people confuse “recovery” with “recovered.” The economy has recovered the real output lost during the last recession, but it has not recovered the jobs lost, the factory output lost, the stock market value lost, the house value lost, or the confidence lost. Nevertheless, even though these various items have not yet recovered, they are in the process of recovering.

This gets me to the recent data on manufacturing and employment. Many have interpreted the data as soft. I would interpret it as a return to a more sustainable growth rate for the economy.

First, the ISM manufacturing index is a diffusion index, which means that it requires a somewhat different interpretation than most economic statistical series. For example, a reading in excess of 42.5 percent, over a period of time, generally indicates an expansion of the overall economy. The index in May was 53.5 percent in May, down from the 60.4 percent in April. Market participants seemed to focus far more on the drop in the index rather than the level of the index, leading to a flight to quality on the part of investors. This contradicts the fact that the information about the economy from a diffusion index is in the level more so than the change.

As shown in Chart 1, the ISM manufacturing index tends to be very volatile around an essentially flat trend line of about 51 percent since 1974. Over that period, real GDP growth averaged 2.7 percent annually. Indeed, the past relationship between the ISM manufacturing index and the overall economy indicates that an ISM index of 53.5 percent, if maintained for an extended period, corresponds to a 3.8 percent increase in real gross domestic product annually. So far this year, the ISM index has actually averaged 59.5 percent, which based on past relationships corresponds to a 5.9 percent increase in real GDP. In other words, the ISM manufacturing index, even at 53.5 percent, still remains very much in line with the Laufenberg Quarterly forecast for all of 2011 and 2012.

Second, the headline statistics in the May employment report released this morning was disappointing across the board. The unemployment rate increased to 9.1 percent in May from 9.0 percent in the preceding month. Although the consensus pretty much expected the unemployment rate to edge up, it apparently was not fully discounted in the financial markets.

On the other hand, nonfarm payroll employment increased 54,000 versus the consensus estimate of a 135,000 gain and gains that averaged 222,000 for the prior three months. The disappointment was somewhat expected given the sluggish ADP number reported earlier in the week.

However, there is a statistic included in the details of the monthly employment report that may be more helpful in assessing the economy’s performance in the current quarter than either of the headline statistics. It is the index of aggregate weekly hours worked. As shown in Chart 2, the index of weekly hours worked tends to be very cyclical, falling during recessions and rising during expansions. However, unlike the ISM index, the long-term trend in this index is upward. Unlike the headline statistics, hours worked seem to be more coincident with overall economic activity than either the unemployment rate or payroll employment. At the moment, the hours worked index continues to climb, suggesting that at least for now the expansion remain intact. There is no hint in this statistic that the hiccup in the real growth last quarter will continue this quarter.

Through May, this index is on track to increase at a 3.1 percent annual rate in the second quarter versus the first quarter. Recall that the change in real output is essentially the sum of changes in hours worked and productivity. If aggregate hours worked are up 3.1 percent annualized in the second quarter, it bodes well for real output growth even without the benefit of any improvement in labor productivity.

The key to sustained output growth will be whether final demand will be strong enough to justify more hours worked, even with some improvement in productivity. For example, a look at motor vehicle sales and production now versus what might be coming in the third quarter seems quite favorable for more hours worked. In particular, light vehicle sales in May were very disappointing, but it was mostly attributed to the lack of supply rather than the lack of demand. In fact, Ward’s Automotive reported this week that production by domestic producers was scheduled to surge in the third quarter. I estimate that this surge in auto output could add at least 2.0 percentage points to third-quarter real output growth alone.

Chart 2 Aggragate Hours

The bottom line is that I am reluctant to lower my estimate of real GDP growth for the current quarter owing to the hours worked data in this morning’s employment report. Moreover, I am equally reluctant to back away from my very aggressive estimate of real GDP growth in the third quarter because of the surge in production scheduled by automakers. Stay tuned. As usual, there is plenty to follow. period


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For the current economic forecast, as well as other analysis and commentary, please visit the Stonebridge Capital Advisors website.

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The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.

2011 Commentary

Living in interesting times
-- September 8, 2011

A not so pleasant surprise!
-- September 2, 2011

-- August 16, 2011

Debt ceiling politics
-- July 25, 2011

Q2 growth: Another disappointment likely
-- July 14, 2011

Interpreting the ISM manufacturing index and the employment situation report for May
-- June 4, 2011

A slower start to 2011 than anticipated earlier
-- April 14, 2011

Is the dollar's status as the reserve currency at risk?
-- March 21, 2011

More trouble in the Middle East
-- February 26, 2011

Searching for the next debt crisis
-- January 13, 2011

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