Business activity in manufacturing contracted at a similar rate in August compared with July as demand remains very weak and firms are reluctant to boost output or invest in new capacity given election and interest rate uncertainty.

The Institute for Supply Management's manufacturing index edged up to 47.2 in August from 46.8, the year's low, in July, barely missing expectations for a 47.5 reading.

New orders declined to 44.6 in August from an already bad 47.4 in July. Employment edged up to 46.0 from 43.4 in July as firms continued to use layoffs to rightsize their businesses given lack of business and a dim view of the future. Supplier deliveries slowed a bit to 50.5 in August from 52.6 in July.

Prices rose to 54.0 in August from 52.9 in July. Timothy Fiore, the ISM survey chief, said the uptick partly reflected supply disruptions linked to Hurricane Beryl in July. Commodity markets are weakening with diminished demand, which suggests prices are headed lower, he said.

Fiore predicted no real recovery in the manufacturing sector until year end given the weight of election uncertainty, even if the Federal Reserve starts cutting rates in September, as expected.

After falling 1.7 points to 46.8 in July for its lowest score of the year, ISM manufacturing is expected to rebound 0.7 points to 47.5 in August. This index has missed Econoday's consensus estimate the last four reports in a row.

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.