The Big Idea
Stephen Stanley | November 5, 2021
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The October ISM Non-Manufacturing Survey report offered a striking testament to the strength of the economy. Indicators of business demand surged while several indicators related to supply constraints pointed to widespread bottlenecks. The economy is overheating in a manner not seen in decades.
ISM Non-Manufacturing Survey
The ISM, formerly known as the NAPM, has been surveying manufacturers every month since the 1940s, offering an incredibly rich and detailed chronicle of the factory sector. In 1997, the organization began to canvas purchasing managers from other sectors of the economy. The report is sometimes referred to as covering the services sector, but it is actually much broader than that, including not only services but also construction, mining, retail, wholesale and transportation. In any case, the non-manufacturing data now go back nearly 25 years, not as long as we might like but certainly enough to draw valid historical comparisons.
The survey asks purchasing managers whether various aspects of their business increased, decreased, or was steady in the prior month. The responses are used to compile diffusion indices, measuring the breadth of strength or weakness. A composite index is calculated based on the Business Activity (Production), New Orders, Employment, and Supplier Deliveries components.
The composite ISM Non-Manufacturing index surged in October to an all-time high of 66.7 (Exhibit 1). The economy by this gauge is hotter than it has been at any time in the past 25 years. In fact, the top five readings in the history of the composite index have all occurred since March this year. The October figure was especially impressive, shattering the prior record set in July by more than 2.5 points.
Exhibit 1: ISM Non-Manufacturing Composite Index
The two primary indicators of demand in the ISM survey are Business Activity, which is essentially a production gauge, and New Orders. Both of these indicators also set new all-time highs in October (Exhibit 2 and Exhibit 3).
Exhibit 2: ISM Non-Manufacturing Business Activity Index
The Business Activity gauge surged by 7.5 points to 69.8 in October, a new record going back to 1997, eclipsing the previous high set in March.
Exhibit 3: ISM Non-Manufacturing New Orders Index
Meanwhile, the New Orders measure jumped by more than six points last month, also nearly reaching the 70 mark. The October reading was easily a new all-time record, outpacing the March 2021 reading by 2.5 points.
One valuable aspect of the ISM surveys is that they offer insight into both the demand and supply sides of the economy. Several of the components of the ISM Non-Manufacturing survey directly measure elements of the supply bottlenecks currently plaguing the economy.
The ISM Supplier Deliveries index measures vendor performance. Are firms getting their supplies faster or are delays building? A higher reading points to slower deliveries. In October, the index jumped by 7 points to 75.7, the second-highest reading ever, behind only April 2020, when the economy shut down due to Covid (Exhibit 4).
Exhibit 4: ISM Non-Manufacturing Supplier Deliveries Index
The ISM survey also asks about order backlogs. This gauge surged by more than five points to 67.3 in October, yet another category establishing a new all-time record by a significant margin (Exhibit 5).
Exhibit 5: ISM Non-Manufacturing Order Backlogs Index
Input costs offer another angle to view the supply side of the economy, as firms are bidding up the price of key materials, many of which are in short supply. The prices measure jumped by more than 5 points last month to 82.9, the second-highest reading on record, behind only September 2005, when Hurricane Katrina sparked a crisis in the oil and gas industry (see Exhibit 6). There were 40 commodities reported up in price in October (vs. only 1 reported down in price) and 27 reported in short supply.
Exhibit 6: ISM Non-Manufacturing Prices Index
Finally, the tightness of the supply side of the economy has resulted in exceedingly lean inventories. The ISM Non-Manufacturing survey asks purchasing managers whether their firms’ inventories are too high or too low. If a majority say “too high,” the index will be above 50, and vice versa. In October, the measure plunged to 37.3, the second-lowest on record, behind only June of this year (Exhibit 7).
Exhibit 7: ISM Non-Manufacturing Inventory Sentiment Index
No stagflation here
The pictures of the ISM Non-Manufacturing Survey results tell a compelling story. The demand side of the economy is red-hot, and the supply side is simply unable to keep up. It is too bad that these data were not compiled back in the 1970s and 1980s, to offer further historical perspective on the current situation. In any case, these data should put to rest for now any concerns that the economy is headed for a bout of stagflation soon—slow growth and high inflation at the same time. While the inflation side of equation qualifies, the economy is far from sluggish or weak.