U.S. Manufacturing Takes The Worst Hit Since June 2009 As Sequester And Slowing Consumption Bite

As many try to minimize the impact of fiscal restraint and the sequester on the U.S. economy, the May manufacturing ISM printed at a contractionary 49%, the lowest reading since June 2009.  While it is too early to determine if this is just a slowdown or will ultimately result in an outright contraction, the manufacturing sector is suffering from “sluggish” economic conditions and “flattening” demand both in the U.S. and abroad.  The stock market didn’t seem to care much, falling initially but jumping right back to higher highs in the aftermath of the report.

The first contraction in manufacturing activity since last November indicates “a flattening or softening in demand due to a sluggish economy, both domestically and globally,” the Institute for Supply Management noted on Monday.  And, while stock markets are firing on all cylinders, the underlying economy is showing signs of fatigue.

The overall reading fell 1.7% to 49% in April, led by big declines in the production index and new orders, which fell 4.9% and 3.5% respectively.  The employment index ticked down 0.1 percentage points but remained in expansionary territory, while the price index fell 0.5 percentage points, indicating prices for raw materials declined in May, and giving further evidence of deflationary tendencies in the economy.  Deflation is the Federal Reserve’s worst enemy, giving Chairman Bernanke & Co. reason to question whether it is the right time to taper its asset purchase program, or QE.

May’s contractionary ISM reading marks the third consecutive decline in the index, which needs to fall “well below” 47% before it actually brings GDP down, according to Capital Economics.  Manufacturing output may start to contract soon, which means GDP could come in softer in the second quarter, they added.  Indeed, Barclays ’ GDP tracking estimate stood at 1.1% for the second quarter after the release of construction spending numbers, which rose less than expected on Monday.

With the support of the Federal Reserve, U.S. stock markets managed to hit record highs over the past few weeks, despite a recent slowdown.  While the economy seems to be picking up, led by sectors like housing, as evidenced by the stock prices of homebuilders like KB Home and Lennar , investors are also worried that stock market strength may be artificial.  Output remains subpar, while key industries are still struggling, such as the computer and electronic sector, which reported contraction in May.  Weakness goes beyond the U.S., though, with global bellwethers like Caterpillar , Walmart, and McDonald's all underperforming the market this year.

Survey participants blamed the government and slowing consumption for the reading, according to ISM.  Another dangerous trend seen in the report is difficulty in hiring skilled workers, indicating unemployment could be structural, rather than cyclical, in certain industries.

The U.S. economy may be outperforming so-called advanced economies, but it has by no means recovered from the crash.  Growth is sluggish despite incredible monetary support from the Federal Reserve.  While manufacturing represents only 22% of the economy, according to High Frequency Economics, it indicates things are not as good as the stock markets suggest they are.