The ISM Manufacturing Index came out at the beginning of the month and offers a dim view of the next three months for US manufacturing as well as for stocks. The key data we focus on in the ISM is the relationship between New Orders to Inventory. The ratio leads the overall headline by about three months (sometimes more, sometimes less). The ratio fell to a four year low, and it shows that we’ll see a fall in the headline ISM, which is already below 50.
Much more importantly, though, is that the S&P 500 six month change is highly correlated to the ISM and the New Orders/Inventory ratio. Currently the S&P 500 has been rising, yet the ratio is falling. This divergence is rare and generally doesn’t persist. A fall in the ISM indicates that we should expect weaker equity markets. The poor reading is also confirmed by the negative diffusion of regional Fed surveys, where most of them have disappointed lately and declined. The diffusion of regional surveys leads the six month change in the S&P 500 by about three months.