U.S. manufacturing activity unexpectedly perked up in December, edging closer to growth thanks to signs of recovery on the demand side, but it was still in contraction for the ninth straight month amid lingering concerns over President-elect Donald Trump's tariff threat and firms continued to shed workers, the latest monthly data from the Institute for Supply Management showed.The sector index compiled by the ISM, which indicates general direction, rose for the second consecutive month, up 0.9 percentage point at 49.3 in December after rising 1.9 points to a five-month high of 48.4 in November and unexpectedly slipping to 46.5 in October. The latest figure came in much higher than the median economist forecast of 48.5.

The months of December and January tend to show wide swings because of statistical adjustments made to correct month-to-month surges or plunges caused by seasonal factors, such as much shorter operation days during the yearend holiday season and disruptions in winter weather for those two months. Despite those factors, Timothy Fiore, chair of the ISM Manufacturing Business Survey Committee, told reporters,"On the demand side, all are heading in the right direction."

"Demand showed signs of improving, while output stabilized and inputs stayed accommodative," Fiore also said in a statement."Demand improved, production execution met November's performance (and companies' plans), de-staffing continued (but should end soon), and price growth was marginal."

Fiore told reporters that he still expects the ISM manufacturing PMI to rise above the make-or-break point of 50 in the January-March quarter,"if not in January, probably in February," at last emerging from the post-pandemic slowdown that was caused by heightened geopolitical risks and uncertainties over how the U.S. fiscal and monetary policy-making evolves.

Among the five subindexes that directly factor into the manufacturing PMI, four posted solid gains: the new orders index at 52.5 (+2.1 points), the production index 50.3 (+3.5), the employment index 45.3 (-2.8), the supplier deliveries index 50.1 (+1.4), the manufacturing inventories index 48.4 (+0.3). Among other notable moves, the index for backlog orders at 45.9 (+4.1) hit a nine-month high"as new orders coupled with stable production levels slowed the rate of declining backlogs" and the new export orders index at 50.0 (+1.3), reaching a seven-month high and stabilizing.

Purchasing managers are not expected to report any significant letup in the ongoing contraction in business activity with the manufacturing index at 48.5 in December versus 48.4 in November.

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.