Does the ISM Services Index Really Reflect the Real World?

Please consider the November 2022 Services ISM^® Report On Business^® 

Economic activity in the services sector grew in November for the 30th month in a row — with the Services PMI^® registering 56.5 percent.

“The Supplier Deliveries Index registered 53.8 percent, 2.4 percentage points lower than the 56.2 percent reported in October. (Supplier Deliveries is the only ISM^® Report On Business^® index that is inversed; a reading of above 50 percent indicates slower deliveries, which is typical as the economy improves and customer demand increases.)

“The Prices Index was down 0.7 percentage point in November, to 70 percent. Services businesses still continue to struggle to replenish their stocks, as the Inventories Index contracted for the sixth consecutive month; the reading of 47.9 percent is up 0.7 percentage point from October’s figure of 47.2 percent. The Inventory Sentiment Index (44.2 percent, down 2.2 percentage points from October’s reading of 46.4 percent) contracted for the fourth month in a row.

S&P Global US Services PMI™

Next please consider the S&P Global US Services PMI™

• The seasonally adjusted final S&P Global US Services PMI Business Activity Index registered 46.2 in November
• Quicker fall in new orders weighs on service sector output 
• Slowest rise in cost burdens since December 2020
• Selling price inflation softening again  

November data signalled a faster contraction in business activity across the US service sector, according to the latest PMI™ data. The fall in output was the solid overall and the second-sharpest since May 2020. Contributing to the decline was a steeper decrease in new orders, as domestic and foreign client demand remained weak. Efforts to entice customer spending were reflected in the slowest rise in output charges since October 2020. Softer upticks in selling prices followed easing cost pressures, as input prices increased at the slowest rate in almost two years.

Subdued client demand led to a strong decline in backlogs of work, with concerns for future new order inflows driving below-average levels of business confidence. Nonetheless, efforts to fill long-held vacancies saw employment rise marginally.

The seasonally adjusted final S&P Global US Services PMI Business Activity Index registered 46.2 in November, down from 47.8 in October but broadly in line with the earlier released ‘flash’ estimate of 46.1. The latest headline figure indicated a solid decrease in output at service providers. The fall in business activity was largely linked to lower new orders and subdued client demand. The rate of contraction was the fastest since August and among the sharpest on record (since October 2009).  

Chris Williamson, S&P Global Chief Economist Comments

•  “The survey data are providing a timely signal that the health of the US economy is deteriorating at a marked rate, with malaise spreading across the economy to encompass both manufacturing and services in November. The survey data are broadly consistent with the US economy contracting in the fourth quarter at an annualized rate of approximately 1%, with the decline gathering momentum as we head towards the end of the year. 
• “There are some small pockets of resilience, notably in the tech and healthcare sectors, but other sectors are reporting falling output amid the rising cost of living, higher interest rates, weaker global demand and reduced confidence. Struggling most of all is the financial services sector, though consumer facing service providers are also seeing a steep fall in demand as households tighten their budgets. 
• “A striking development is the extent to which companies are increasingly reporting a shift towards discounting in order to help stimulate sales, which augurs well for inflation to continue to retrench in the coming months, potentially quite significantly.”  

Diffusion Indexes 

Curiously ISM has the PMI tagged ^® while S&P has PMI tagged as ™ so be careful when using that term.

Both the ISM and S&P are diffusion indexes. That means only direction, not magnitude matters.

For example, a company firing 500 workers is offset by another adding 2 workers. 

The ISM and S&P supposedly measure the same types of businesses but the results are often dramatically different.

The ISM reports have for years been stronger than than S&P reports. However, the recent ISM manufacturing report went into contraction, catching up a bit with S&P.

Huge PMI Divergences

If you want to believe the economy is rip roaring, then you believe ISM. If you think the economy is in recession, then you believe S&P. 

If you are in the camp the economy is weakening but not in recession yet, then average the two. (56.5 + 46.2) / 2 = 51.35.

Jobs vs Employment 

Payrolls vs Employment Since March 2022

• Nonfarm Payrolls: +2,692,000
• Employment Level: +12,000
• Full Time Employment: -398,000

The jobs report provides another huge set of divergences. The discrepancy between jobs and employment continues for the eighth month.

Many contend the discrepancy is noise. I have been following jobs discrepancies for at least 15 years and have not seen a jobs vs employment discrepancy go on this long.  

And at economic turns, the admittedly more noisy household survey (employment) tends to lead.   

Finally, in Q2 the BEA revised a huge discrepancy between GDP and GDI (gross domestic product and gross domestic income) way to the downside. 

GDI was well ahead of GDP although both are supposed to measure the same thing. Following the revision, GDP is now outpacing GDI. Again, you are free to believe what you want or average them for a muddle through position. 

For further discussion of the jobs divergence, please see Another Strong Jobs Report? Phooey, and I Can Prove It

For further discussion of the GDP vs GDI divergence, please see “No Recession” Idea Based On GDI Was Just Revised Out the Window

In general, revisions in weakening economies tend to be to the downside. Revisions in economies coming out of recession tend to be to the upside. 

But if you do not want to take a stand, just average everything. 

My Take: Expect negative revisions and eventual resolution to the downside on these divergences.

This post originated at MishTalk.Com.

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