The ISM manufacturing index rose to 54.9 in May compared to 54.8 in April. Expansion remains the signal as production, new orders and employment remain in growth mode. Rising input costs will pressure profits.

May Signals Expansion, Factory Activity Still Solid

Consistent with several regional purchasing managers (Chicago, Philadelphia) indices released over the past few weeks, growth in the manufacturing sector continues to improve. The May ISM came in at 54.9 (top graph). When we examine the graph, we witness how much intracycle volatility is characteristic of manufacturing sentiment, so ups and downs are endemic to this survey. We estimate industrial production up 2.0-2.5 percent in the second half of 2017.

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The production index came in at 57.1 and is now slightly above its twelve-month average. Moreover, the pipeline for activity remains positive as new orders were up at 59.5. Strength in new orders (middle graph) stems, in part, from the improved global backdrop. Fourteen sectors reported a gain in orders including paper, primary metals and machinery. Export orders came in at 57.5, with 11 industries reporting growth including textiles, wood and paper. While not seasonally adjusted, the index indicates continued gains in exports.

The employment index came in at 53.5 with 11 industries reporting job gains to include furniture, electrical equipment and appliances. Manufacturing hiring remains on the upswing, with the employment index up near the highs since mid-2011. The index indicates another solid gain is in store for manufacturing payrolls in May.

Supplier Deliveries Indicate Further Economic Gains

The supplier delivery index remained above breakeven indicating slower deliveries – a positive for growth. Slower deliveries are associated with incoming orders above the pace of outgoing deliveries. These backlogs signal pent-up production for the future. Eleven industries reported slower supplier deliveries in May including plastics, furniture and electrical equipment.

Input Inflation Pressures Mounting: Challenge for Profits

Price pressures continue to mount in the manufacturing sector. Prices paid, bottom graph, came in at 60.5 in May with 15 of the 18 sectors reporting higher prices paid. Among those paying higher prices include electrical equipment, appliances, apparel and furniture.

Commodities were up in price, including aluminum, corrugated boxes, steel and steel tubing. Capacitors and electronic components remain in short supply.

Our outlook for producer prices remains at 2 percent plus for 2017 compared to 0.4 percent for 2016 and an outright drop in prices in 2015. Rising input prices and rising interest rates will combine to put pressure on many firms’ profit outlooks going forward. We estimate pre-tax profit growth at 3.4 percent in 2017.

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