ISM and Recessions

The Institute for Supply Management’s (ISM) Manufacturing Index, a diffusion index based on monthly surveys of purchasing managers at around 300 firms in the United States, has beaten consensus expectations handily over the past few months. The index hit a cycle-to-date high of 60.8 in September before moving slightly lower over the subsequent two months, though the November reading of 58.2 remains strong (a reading above 50 indicates expansion). The ISM often fluctuates significantly month to month, meaning the September number may not end up being the cycle peak. However, any time the ISM hits a new cycle high then starts to move lower, it causes some to question if the economy is slowing and may eventually move toward a recession.

“History has shown that a peak in manufacturing does not mean recession is imminent. Indeed, the economy and the financial markets have exhibited strength despite the trend reversal in manufacturing, which has typically provided opportunity for diversified investors,” according to John Lynch, Chief Investment Strategist.

Over the past five economic cycles, it has taken the United States 45 months on average to enter a recession following a peak in the ISM. Meanwhile, the average cumulative S&P 500 Index price return during those time frames (using end of month returns) was 56.7%, as shown in the table below. Note that this average includes periods of very strong returns in the mid- to late-‘80s and ‘90s, and one period of negative returns in the early ‘80s, which is an indication that not every cycle is equal; but the overall story remains that a peak in ISM manufacturing does not generally mean that equity gains are over and a recession is around the corner.

It may still be early to call a peak on ISM for the current cycle with the November reading of 58.2 remaining firmly in expansionary territory and not far from recent highs. However, given concerns about a potential peak in ISM coinciding with a flattening yield curve (see our recent Bond Market Perspectives, “Further Flattening” for more on the yield curve), we thought it would be a good time to remind investors that recent history suggests that economic expansions and stock market gains can continue for some time after a peak reading for the ISM Manufacturing Index.

IMPORTANT DISCLOSURES

Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.

The Institute for Supply Management (ISM) Index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The economic forecasts set forth in the presentation may not develop as predicted.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

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