As an almost total surprise, the Institute for Supply Management’s factory index(NAPMPMI:IND) rose to its highest level in three years.   The 55.7 level indicates stronger growth in manufacturing than any economists had predicted.  Most were looking for between 50 and 55.

The index is based on a survey of manufacturing executives.  Taken by itself, this index seems incredibly positive, but several questions arise when seeing such “growth”.  Unemployment is still edging up, expected to go to 9.9%-10.1% in this Friday’s numbers.  Consumer spending was just reported to have dropped by it’s largest margin in 9 months.  So if there are fewer consumers, and the consumers that do have money are spending much less of it, why would factory output go up?

Obviously, the index is a highly-subjective non-economic indicator of factory output so it’s difficult to know for sure if manufacturers are increasing production or simply slowing the rate at which they reduce their output.  If we assume that factories are truly making more goods, and we know fewer goods are being purchased, the only reasonable driver for this is inventory levels.

For several months, manufacturers have been idling factories and filling orders mainly from stockpiles in order to cut costs.  It would appear that by looking at the inventory index (now at 46.9%), manufacturers have stopped slashing their inventories and are now moving into a mode of sustaining their new lower levels of stock.  This would be more indicative of a sector of the economy that is not improving, but rather has adjusted itself to the new economic norm.

When hearing good or bad economic news, understanding the factors that cause the news is often more-important than the news itself.

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