Factory Index Dipped in September, but Still Indicates Expansion

The U.S. factory sector continued to expand in September, but at a slower pace, as the Institute for Supply Management manufacturing index dipped to 54.4 from 56.3 in August.

Readings above 50 indicate an expansion -- under 50, a contraction. A Bloomberg survey had expected the manufacturing index to dip slightly less, to 54.5 in September. The index was at 55.5 in July, and 56.2 in June.

Despite the index's decline, September nevertheless marked the 14th consecutive month manufacturing activity has expanded.

And while three of four key index components fell in September, investors should keep in mind that each remains above levels that indicate increased commercial activity or growth.

The closely watched new orders component fell to 51.1 from 53.1, the production component declined to 56.5 from 59.9, and the employment component decreased to 56.5 from 60.4. The prices component, however, surged to 70.5 from 61.5.

New Orders Slowdown Noted

Norbert J. Ore, chairman of the ISM's Manufacturing Business Survey Committee, said the nation's factory sector continued to expand in September, but the new orders drop bears watching.

"While the headline number shows relative strength this month as the PMI reading of 54.4% is still quite positive, the overall picture is less encouraging. The growth of new orders continued to slow, as the index is down significantly from its cyclical high of 65.9% [January 2010]. Production is currently growing at a faster rate than new orders, but it typically lags and would be expected to weaken further in the fourth quarter," Ore said in a statement. "Manufacturing has enjoyed a stronger recovery than other sectors of the economy, but it appears that weaker growth is the expectation for the fourth quarter. Both the inventories and backlog of orders indexes are sending strong negative signals of weakening performance in the sector."

Respondents' comments in the September survey reflected a manufacturing sector that down-shifted slightly in the third quarter:

• "Business results (top and bottom line) continue to meet or exceed our operating plan and exceed prior year performance by double digits" (chemical products sector);
• "Business continues flat relative to prior month and is expected to remain flat. Commodities continue to be the main concern heading into 2011" (food, beverage and tobacco products sector);
• "Our business is softening due to seasonal considerations. Overall, our situation is much better than 2009" (machinery sector);
• "Customers seem to be pulling back on orders. I suspect that they are trying to reduce their inventory for the approaching year-end" (transportation equipment sector).

The September's ISM manufacturing index confirmed an ongoing industrial expansion, but one that has moderated. Further, given that most components trended up throughout 2010, a pull-back, or pause, is not that unusual. However, if the slow-down continues over months, particularly regarding new orders, that would be a danger sign. For now, classify September's data as a period of adjustment to a slower growth rate.