Wednesday, July 2, 2008

Growth: Is it back on track?

The ISM surprised us in June by rising. The rise was not much. Just a gain to 50.2 from 49.6. But in moving up above 50 The ISM is in a cohort, or range, from which the ISM is rarely dips into recession.

Recession Probability &
The ISM PMI Values
ISM Value Of Recession
40 and lower 87.5%
35-40 74.2%
45-40 59.2%
50-45 15.4%
55-50 3.7%
60-55 1.7%
Current value: 50.20

Recession seems improbable
The ISM table above shows that in the range of 50-55, recession occurs less than 4% of the time. In the range 45-50, recession occurs about 15% of the time. But slip below 45 and the recession probability surges to 59%.

But is it?
Still, the ISM component readings registered weaker in their ranges constructed by ordering instead of by value. If we order the ISM and its component values by a simple queuing process from low to high the June component rankings would reside lower in the queue's percentage position than they would rank as a percentage of their cardinal position in a range of highs and lows.

This suggests that the current readings are not as strong as their range percentiles say.

Adjusting the PMI
To flesh this out, look at the PMI reading itself. At 50.2 it stands in the 43rd percentile of its range, below the range midpoint. Yet, by simple ranking (ordinal not cardinal) the PMI also stands in the lower 23nd percentile- much weaker. That means only 23 percent of the PMI observations stand below it, whatever their values. If the PMI were to slip to register the raw reading that produces the raw reading as a percentile that matches its ordinal percentage reading, it would have to drop to a raw reading of 44.9. And at 44.9 the probability of recession is much higher.

How solid is the PMI?
What these numbers suggest is that the PMI does not rank as solidly as the PMI value's percentile standing suggests. Its precise level is not yet as low as it gets to be in recession, true. Yet in terms of the number of weaker readings that lie below it, there are not so many of them. This raises the possibility that the ISM could turn weaker quicker than we expect. It is a finding in line with what we are seeing in the economy at large.

Reconciling the ISM's standing with reality
Weak economic readings persist but they are not of the magnitude of weakness that recessions generate. Still, they seem low by our own experience, and they are. They are weaker than their current level seems (at least for the ISM ) since only 23 percent of the time are they worse. It is not recession yet. But it might not take that much to tip us there. The BIS (Bank for International Settlements) already has warned that oil prices put us closer to the tipping point.

So, is growth more assured with the ISM's recent move up over 50? I don't think so.