Divergent PMI Readings Converge on Inventories

America’s twin manufacturing purchasing managers’ indexes (PMIs) hit Friday, and in a funky twist, they diverged yet said the same thing—and suggested manufacturing headwinds should soon morph to tailwinds. Heavy industry is only a small piece of US GDP, but a flip from being an incremental negative to a small positive is still good for stocks’ economic drivers overall.

Where most countries have only one flavor of PMI—usually S&P Global’s—the US has two: S&P’s and the Institute for Supply Management’s (ISM’s). Both are surveys measuring the percentage of businesses reporting rising activity across a range of questions. Both report their findings as an index level, with 50 being the dividing line between growth and contraction. And both report growth’s (or contraction’s) breadth rather than its magnitude, making them timely but not airtight readings of current economic output. ISM’s reading has been around for decades—far longer than S&P Global’s—but S&P Global’s surveys more businesses, so both are useful and credible, in our view. Beyond that, they differ a bit in their industry inclusions and weightings. This, plus the difference in sample size, can occasionally cause divergence.

This happened in February. ISM’s reading slipped from January’s 49.1 to 47.8, implying a wider-spread contraction and notching the 16^th straight month below 50.^[i] Its new orders component, which signals future production—making it the most forward-looking piece—fell back into contraction, from 52.5 to 49.2.^[ii] Yet S&P Global’s manufacturing PMI jumped at the fastest rate since July 2022, rising from January’s 50.7 to 52.2—ahead of the preliminary estimate of 51.5—the second straight expansion after spending most of 2023 below 50, and “total new orders grew at a strong pace that was the fastest for 21 months.”^[iii]

So, divergent. But dig a little deeper, and you find both reports pushing the notion that businesses are pretty much done running down inventories—part of their preparations for the recession that never came last year—and are switching to restocking mode. With raw materials no longer in short supply, S&P Global states plainly that “stock building became a renewed goal” and “manufacturers noted that some clients had worked through safety stocks and were looking to replenish inventories.”^[iv] ISM’s release matched this, describing customer inventories as “too low” at 45.8.^[v] Restocking was a theme in the sample survey responses, and businesses expect this to boost orders and production later in the year.

Seems on point to us. Businesses spent most of the past two years getting lean in anticipation of the widely forecast recession, which meant slashing inventories. Now, inventories are always open to interpretation. Sometimes a drawdown is a deliberate cutback, and sometimes it means supply can’t keep up with demand. Against the backdrop of falling business investment in equipment in four of the last five quarters, not to mention Tech layoffs, inventory drawdowns have looked to us like businesses trimming the fat to survive tough times. But the recession never arrived, and the PMI responses make pretty clear businesses have reached the limit of what they can cut. This points to a likely pickup in investment and restocking, which would add economic tailwinds.

Again, not major tailwinds. Services is a much bigger piece of US GDP, and its continued growth kept overall output humming along even as manufacturing struggled last year. But manufacturing returning to growth is no bad thing. It would increase the expansion’s breadth and strengthen its foundation while increasing investment. It may also be one more signpost of a potential shift from growth to value leadership later this year, though “wait and see” remains the watchword on that front, in our view.