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ISM Services Report Hints at Mixed Bag of Sentiment; (AA)

Posted on | July 6, 2009 Time: 12:03 pm |

I suppose every analyst has their favorite economic indicators, whether due to the specific sectors they follow or their slant towards bottoms-up or top-down analysis. To the latter, I try to as much of both as my resources allow, and to the former, I am a big fan of the ISM services report. (you can check out today’s release here.)

The PMI report from the Institute still gets the majority of press coverage, but let’s get real - we haven’t been a manufacturing economy for quite some time.

For a little background on the structure of this indicator, check out the snippet of my tutorial on the Services Report. As to the headline index, it registered 47% in June, the highest reading since Sept. ‘08 but still in “contraction” territory….no surprises there. The number came in slightly above consensus estimates, but not enough to be meaningful. The biggest drag on the headline figure continues to be the employment index, which came in at 43.4%; this is also unsurprising following the weak jobs report from last week.

Business Activity

But further down in the report are some promising data points, such as the percentage of respondents saying that business activity was higher in June than in May; this figure rose from 20% to 28%. Industries reporting the largest rise in activity were Real Estate, Rentals & Leasing, Food Services, Accomodations, and Entertainment. The laggards were led by Mining, Forestry, and Transportation/Warehousing.

New Orders - Domestic

The New Orders index also notched an impressive 6 percentage points of gain in repondents saying business was improving, rising from 23% to 29% in June. The same industries were on the + and - side as above.

Inventories

As to Inventories, the Index continues to show marked weakness; Mining leads the list of industries seeing higher inventories in June, followed by Real Estate. The sub-index Prices took a rather large leap forward in June, registering 53.7%, up from 46.9% in May. A total of 9 industries reported higher prices paid in June, while seven reported a decline. Miners seems to be getting their singular break here, as prices fell most broadly for them.

Exports

And finally, the award for Most Confusing Index goes to Export Orders. 33% of purchasing managers reported higher export orders in June, up big time from the 11% in May. But a higher number also reported lower orders in June, led again by….you guessed it….mining. We seem to be delving into the world of the have’s and have-not’s here, a trend worth examing closer as companies report 2nd qtr earnings.

Conclusions

  • While it appears that many industries have “right-sized” themselves to current levels of demand, the picture doesn’t look pretty for domestic miners and other commodity plays heading into the earnings season. Many investors (myself included in terms of Secular Trends holdings like Peabody (BTU) and Alcoa (AA)) are hoping that export demand will be able to offset what we know to be low levels of domestic demand.
  • Look for weak guidance from Alcoa on Wednesday, and also for many domestic energy producers with disproportionate dependence on international revenues. Alcoa looks doubly troubling considering the well-publicized woes of the auto and aerospace industries. Tin foil and coke cans aren’t going to save them anytime soon, and the slight bump in LME pricing from the 1st qtr to the 2nd (roughly 14%) will not be enough to stave off poor guidance and steady-to-rising inventories on the major metals exchanges.
  • I do feel that the company’s cost saving efforts will be effective in slicing some expenses from the income statement, and the prices of key inputs like energy and caustic soda have moderated, but not enough to overcome the extremely high cost of cutting major production facilities.
  • The AA holding in the Secular Trends Model continues to be one of the few laggards (part of my seemingly masochistic strategy to write more about my losers than my winners), but the company balance sheet remains in solid shape. When - not if, but when - core customers begin buying, the slope of the cash contracts for aluminum should turn sharply upward, and I hold firm to my belief that Alcoa will benefit from this more than their competitors. I’ve thought about selling the position multiple times, but at this moment I’m actually looking for a future re-entry point to enlarge the position. I’ll stay focused on the ISM reports to gauge said re-entry.

Ryan Barnes

disclosure: author does not hold positions in the companies mentioned.

More on this topic (What's this?)
ISM Employment Index (What can I do with 10 grand?, 8/3/09)
THOUGHTS ON THE ISM DATA (THE PRAGMATIC CAPITALIST, 8/3/09)
Optimistic ISM Services Lifts Stocks... (Daily US Stock Market Fundamenta..., 7/7/09)
Read more on ISM Manufacturing Index at Wikinvest
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