US manufacturing activity was in contraction territory for the 16th straight month in February, with the key index giving up some of a hefty gain in January in light of a pullback in new orders after a surprise jump, but production appears to be stable without distortion from seasonal adjustments, data from the Institute for Supply Management released Friday showed.

The sector index compiled by the ISM, which shows general direction, fell 1.3 percentage points to 47.8 in February after rising 2.0 points to 49.1 in January. It was weaker than the median economist forecast of 49.5 and remains below 50, which indicates contraction in the sector.

"Demand is at the early stages of recovery, and production execution is relatively stable compared to January, as panelists' companies begin to prepare for expansion," Timothy Fiore, chair of the ISM Manufacturing Business Survey Committee, said in a statement."Suppliers continue to have capacity but are showing signs of struggling, due in part to their raw material supply chains."

Fiore told reporters that the main index should be able to pop above the neutral line of 50 in March or April, adding that the February figure would be just above 49 without unfavorable seasonal factors. Last month he said he was"still bullish" about his prediction made earlier that the index would go above 50 in March.

"I still feel good about breaking 50 in March," he said."I'd like a caveat: Maybe I'm not as confident as I was. Maybe it might be in April but it's going to happen pretty soon because fundamentals are there."

"With the pandemic period of last three years having a significant impact on our seasonal factors, we are starting to feel a little bit of volatility here," Fiore said."We had a 4.2-point benefit in January on new order levels from a seasonal factor; this month (in February) we had a 4.3-point headwind."

He also said February this year had 29 days, an extra working day compared to February in the previous three years, which contributed to volatility in subindexes after seasonal adjustments.

"Panelists' companies essentially maintained output levels from January, but due to seasonality adjustments, expansion wasn't fast enough to avoid a subindex reading in contraction territory," Fiore said in a statement."Overall, production rates have been essentially stable since July 2023, with slight month-over-month declines consistent with reductions in demand and backlog,"

Among the five subindexes that directly factor into the manufacturing PMI, the new orders Index fell 3.3 percentage points to 49.2 in February after rising 5.5 points to 52.5 in January (a pullback was expected). It slipped back into negative territory after posting the first growth in 17 months in January. The production index also dipped 2.0 points to 48.4 in February after rising 0.5 point to 50.4 in January to show growth for the first time in eight months.

The employment index contracted for the fifth straight month. It slipped 1.2 points to 45.9 after falling 0.4 point to 47.1 in January. Firms continued to reduce head counts using layoffs, which accounted for 50 percent of reduction activity, as well as attrition and hiring freezes."Panelists' comments in February were equally split between their companies adding and reducing head counts," Fiore said."This approximately 1-to-1 ratio has been consistent since October 2023."

The ISM manufacturing index has been in contraction the last 15 months and isn't expected to emerge in February, at a 49.5 consensus versus January's 49.1.

The manufacturing composite index from the Institute for Supply Management is a diffusion index calculated from five of the eleven sub-components of a monthly survey of purchasing managers at roughly 300 manufacturing firms nationwide. The survey queries purchasing managers about the general direction (tracked in volumes) of production, new orders, order backlogs, their own inventories, customer inventories, employment, supplier deliveries, exports, and imports. Data on changes in input prices (prices paid) are also tracked. The five components of the composite index are new orders, production, employment, supplier deliveries, and inventories (their own, not customer inventories). The five components are equally weighted. The questions are qualitative rather than quantitative; that is, they ask about the general direction rather than the specific level of activity. Each question is adjusted into a diffusion index which is calculated by adding the percentage of positive responses to one-half of the unchanged responses.

Investors need to keep their fingers on the pulse of the economy because it dictates how various types of investments will perform. By tracking economic data such as the ISM manufacturing index, investors will know what the economic backdrop is for the various markets. The stock market likes to see healthy economic growth because that translates to higher corporate profits. The bond market prefers less rapid growth and is extremely sensitive to whether the economy is growing too quickly and causing potential inflationary pressures.

The ISM manufacturing data give a detailed look at the manufacturing sector, how busy it is and where things are headed. Since the manufacturing sector is a major source of cyclical variability in the economy, this report has a big influence on the markets. More than one of the ISM sub-indexes provide insight on commodity prices and clues regarding the potential for developing inflation. The Federal Reserve keeps a close watch on this report which helps it to determine the direction of interest rates when inflation signals are flashing in these data. As a result, the bond market is highly sensitive to this report.

Importance
The ISM manufacturing composite index indicates overall factory sector trends. The relevance of this indicator is enhanced by the fact that it is available very early in the month and is not subject to revision.

Interpretation
The bond market will rally (fall) when the ISM manufacturing index is weaker (stronger) than expected. Equity markets prefer lower interest rates and could rally with the bond market. However, a healthy manufacturing sector, indicated by rising ISM index levels, bodes well for corporate earnings and is bullish for the stock market.

The level of the ISM manufacturing index indicates whether manufacturing and the overall economy are growing or declining. Historically, readings of 50 percent or above are associated with an expanding manufacturing sector and healthy GDP growth overall. Readings below 50 indicate a contracting manufacturing sector but overall GDP growth is still positive until the ISM index falls below 42.5 (based on statistics through January 2011). Readings in between these two levels suggest that manufacturing is declining while GDP is still growing but only very slowly.

In addition to the ISM manufacturing composite index, the various sub-components contain useful information about manufacturing activity. The production component is related to industrial production, new orders to durable goods orders, employment to factory payrolls, prices to producer prices, export orders to merchandise trade exports and import orders to merchandise imports.

Vendor (supplier) deliveries are an important component of report. The more slowly orders are filled and delivered, the stronger the economic growth and the greater the potential for inflation. When orders are filled quickly, it means that producers don't have as many to fill.

The ISM manufacturing composite index and its sub-components can be subject to some monthly volatility, making the three-month average of the monthly levels more indicative of the trend.