Putting the ISM news in context

Going into today, we knew that manufacturing activity in May was disrupted in the wake of the Japanese tsunami, terrible weather, and early auto shutdowns, but nevertheless the market is having a problem digesting the news that the May ISM manufacturing indices were weaker than expected. Still, as the chart above shows, even with a significant drop in the main ISM index, there is no reason to expect that GDP growth in the current quarter is going to be any weaker than it was in the first quarter. The current level of the ISM index is consistent with GDP growth of 3-4%.

The employment component of the ISM index also fell sharply, but it is still at historically strong levels, levels that have been seen only a handful of times in the past several decades.

A decline in activity had little impact on the inflation fundamentals, with the prices paid index still registering rather elevated levels of price pressures.

Export orders fell sharply in May, but they are historically volatile and still consistent with growth.

Meanwhile, all major commodity indices have turned up from their May lows, including my favorite (above), the CRB Spot Commodity Index.

The May Challenger tally of announced corporate layoffs remained very low, but the May ADP estimate of new private sector jobs dropped much more than expected. Conclusion: hiring plans were disrupted in May, but there is no sign that employers want to reduce employment levels.

I think the proper conclusion to all this is that while economic activity was indeed disrupted meaningfully in May, there is no reason to think that conditions or fundamentals have permanently deteriorated or are getting worse. Indeed, commodity prices are signaling that things are are already on the mend. Consequently, it is likely that U.S. markets are overreacting to the downside, and we should expect better news in the weeks to come.