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The manufacturing sector continues to look strong

This market is determined to view the glass as half empty. This morning I saw headlines that said "factory growth weakens," followed by a story that says the "unexpected decline" in the ISM manufacturing index is a reason for the market's decline today. But as this chart shows, the index has merely dropped to a level that is somewhat less than spectacularly high. Based on past correlations, the index is now pointing to real GDP growth in the second quarter of about 5%, down from 6% a month ago. If Q2/10 GDP growth comes in anywhere near 5%, this market is going to be caught very short.

The same can be said for export orders. The June reading was a lot less strong than May, but May was one of the strongest levels recorded in decades; if things had continued at that pace the economy would have been on a moon shot. As it is, the June reading is unremarkable, and quite typical of what we see during recoveries. In fact, the June level of the index (56) is well above the average of the past 20 years (53.5), and is equal to the average of the index during the period June '03 through June '08, when real GDP growth averaged 2.7%.

Meanwhile, the employment index slipped only marginally, and remains at a level rarely exceeded at any time since the early 1970s.

Finally, the prices paid component of the ISM index registered a significant drop in June, but this is hardly bad news, and is most likely simply a reflection of the fact that energy prices have fallen of late (e.g., gasoline prices at the pump fell about 7% from mid-May through mid-June). In any case, a majority of those participating in the survey (57%) reported paying higher prices in June.

Overall, I would say the outlook for the manufacturing sector remains quite positive, and this strength is quite likely to "spill over" into strength for other sectors as well, thus bolstering the prospects for continued recovery.

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