ISM Index Release Will Provide First Glimpse into Earnings Season

The major economic data releases are relatively light in the first week of the new year.  Of the major releases that we follow, only six of them are on tap this week:

• Tuesday 10:00 - ISM Manufacturing Index
• Wednesday 14:00 - FOMC Minutes
• Thursday 08:30 - Jobless Claims
• Thursday 11:00 - EIA Petroleum Status Report
• Friday 08:30 - Employment Situation (AKA the "Jobs Report")
• Friday 08:30 - International Trade

Heading into the next round of earnings releases, starting on Monday, 9 January when Alcoa (NYSE: AA) reports before the open, we'll pay special attention to Tuesday's ISM Manufacturing Index.  This key release offers insight into whether manufacturing (and the economy as a whole) is growing or declining. To interpret the index, keep in mind these key levels:

Readings above 50 indicate that manufacturing and the overall economy are expanding.  It also indicates that the GDP (Gross Domestic Product) is also growing at a steady pace.

Readings below 50 but above 42.5 indicate that manufacturing is declining, however the GDP is continuing to grow, albeit slowly.

Readings below 42.5 indicate that both manufacturing and the GDP are in decline.  (Remember that the definition of a recession is two consecutive quarters of negative GDP growth.)

The ISM data being released tomorrow is for the month of December, 2016.  Consensus estimates for tomorrow's release is a reading of 53.8.  That follows a prior release of 53.2, so the consensus is for modest growth in both manufacturing and the economy as a whole.

ISM Manufacturing Index Histogram

The index is well off it's Third-Quarter 2014 highs, however since bottoming in January 2016 manufacturing and the GDP have demonstrated modest growth.  This trend is expected to continue in tomorrow's release.

The implications of a surprise away from the consensus estimates may well be in play through the entire earnings season this quarter.  Since it shows the health of manufacturing, a weaker than expected report will imply that earnings in general, especially for the industrial and transportation related industries may similarly disappoint.  Equities in general could retreat following a weak announcement.  On the flip side, the bond market will rally on the indication that the economy is weaker than perceived, and bond yields will retreat.

If, on the other hand, the index reports higher than consensus estimates, we may see some mixed results. The market is currently anticipating a June 2017 interest rate increase. March only shows a 20% chance of an increase, and May only shows a 29% chance. June, on the other hand, is at 47% - nearly 50:50, and the dates beyond June start to reflect the interest rate that will follow the next move.

If the Manufacturing Index is higher than the consensus estimate, this may incent the FOMC to increase interest rates in either the March or May meeting, and in anticipation of that, we may see equities retreat despite the positive economic data.  That will be especially true for companies with a high reliance on debt in their operating model, and will also be true for lower-yielding dividend stocks since the higher interest rates go, the more attractive bonds become for that level of income.  Bonds, on the other hand, will decline and their yields will increase.

Of course, the size of an Index surprise to the upside will determine whether equities advance or retreat.  Coming in at or just a point above consensus will not be taken as bad news for equities.  Several points above, however, the the support that provides to the more hawkish FOMC members will almost certainly be factored into market pricing.

When the Index is released at 10:00 AM EST (15:00 GMT) tomorrow, consider what it signals for corporate earnings, most of which are already in the books and awaiting release, and what it signals for potential shifts in the FOMC monetary policy posture.  This is one of the indicators that may generate tradeable setups, so pay close attention to what it portends.

Happy Trading.