May's U.S. Factory Index Hints at Continued Job Growth

Factory output
Factory output

What's the skinny on May's above-expectations 59.7 reading for the Institute for Supply Management's manufacturing index? It suggests further job gains in the nation's factory sector -- and that bodes well for employment overall as the U.S. economic expansion continues.

While few economists expected May's top-line stat to equal the ISM's 60.4 reading for April, which represented a six-year high, 59.7 was better than the 59.4 Bloomberg survey estimate. And May marked the manufacturing sector's 10th straight month of growth. ISM readings above 50 mean expansion; under 50, a contraction. In June 2009, the index was a far-unhealthier 45.3.

The index's key components will likely be somewhat soothing to stock market bulls. First, although unchanged in May at 65.7, the closely watched new orders component -- a measure of future demand -- continued to show an expansion of demand in the pipeline. Moreover, the flat May reading can be overlooked because the new-orders component had surged to 65.7 in April from 61.5 in March.

Running in the Economy's Favor

Second, the employment component rose 1.3 points to 59.8 in May -- that component's sixth straight monthly increase. This suggests that the recent trend of job growth in the nation's manufacturing sector likely continued in May. Since December, factory employment has risen by 101,000 and has walked hand-in-hand with the rebound in manufacturing that has so far led U.S. GDP growth.

What's more, the 59.8 employment component bodes well for May's job report, scheduled to be released Friday, June 5, by the U.S. Labor Department. The Bloomberg survey estimates that the economy added 540,000 jobs in May, and while May's ISM employment component reading doesn't guarantee that this estimate will be achieved, it does suggest the recent factory employment trend continues to run in the economy's favor. (The U.S. gained 290,000 and 230,000 jobs in April and March, respectively.)

In addition, the production and prices-paid components also confirmed strength in the factory sector. The production component dipped to 66.6 in May from 66.9 in April, and the prices-paid metric also inched lower to 77.5 from 78, but each remained at levels consistent with expanding manufacturers. The prices-paid component suggests that manufacturers are having little trouble obtaining the prices they seek for their goods -- something that bodes well for revenue.

Optimistic Comments from Respondents

Norbert J. Ore, chairman of the ISM's Manufacturing Business Survey Committee, said in a statement that the nearly year-long manufacturing rebound is broadening and is even creating shortages in selected segments. "Employment continues to grow as manufacturers have added to payrolls for six consecutive months. The recovery continues to broaden as 16 of 18 industries report growth," Ore said. "There are a number of reports, particularly in the tech sector, of shortages of components; this is the result of excessive inventory de-stocking during the downturn."

Respondents' comments confirmed a manufacturing expansion that's gaining momentum. "Aftermarket sales increased 25% during the past quarter" (transportation equipment segment). "No signs of the ramp-up abating anytime soon" (machinery segment). "Tight supply conditions exist for electronic components" (computer and electronic products segment). "Sales exceeded budget for the fourth consecutive month" (food, beverage and tobacco products segment).

In sum, May's ISM manufacturing index shows a factory sector that continues to expand, with more jobs and a healthy contribution to U.S. GDP growth. Given the uncertainties arising from the latest global financial crisis, however, investors will probably play it cautious regarding job-growth expectations: They'll put more in stock in such gains only when hiring clearly picks up.