Earlier today, the Institute of Supply Management (ISM) announced that its Purchasing Managers' Index fell for the third month in a row, indicating manufacturing activity is continuing to slow. Specifically, the ISM's manufacturing index fell to 52.0 in September, from 52.9 in August and 53.8 in July.
This latest report on the manufacturing sector follows a report last week from the U.S. Department of Commerce, which revealed that capital goods orders declined 4.4 percent during August, as compared to the same period a year ago.
As I mentioned in an article last Thursday titled Economic Indicators Still Point to Falling Stock Prices, a slowdown in the industrial sector may be the last shoe to drop before economic growth in the U.S. comes to a screaming halt.
Although the U.S. economy has thus far held up quite well in spite of the ongoing housing slump, my research suggests the recent slowdown in non-residential construction spending, accompanied by the slowing manufacturing sector, will lead to a big drop in economic growth over the coming months.
As you can see in the chart below, the last time non-residential construction spending fell sharply, the S&P 500 declined 37 percent. And, while this important component of the economy has continued to grow over the past year, construction activity in the non-residential sector clearly topped out last August and has slowed significantly over the past three months.
Meanwhile, the chart below shows how stock prices in general have historically responded to slowdowns in the manufacturing sector.
Yet, stock prices rallied sharply today on speculation that the Fed will continue to cut short-term interest rates in response to the slowing manufacturing sector.
While further rate cuts are of course a possibility, I urge you to note that the Fed is just as concerned about inflationary pressures as it is about a slowing economy. And, with the U.S. dollar continuing to fall against other world currencies, and commodity prices continuing to rise, my research suggests that the Fed won't lower interest rates again at its next meeting on October 31. I therefore continue to warn you not to get overly excited about the recent increases in stock prices.
And, although the Dow Jones Industrial Average broke out to a new all-time high today, both the S&P 500 and the Russell 2000 are still significantly below previous highs.
Meanwhile, trading volume has been rather light over the past two weeks and the increases in the major stock market indexes have lacked broad participation; only a minimal number of stocks have been responsible for the advances in the market averages. Historically, whenever fewer and fewer stocks participated in stock market rallies, stocks usually declined precipitously over the following months.
So, I continue to recommend you ignore the recent rally in the Dow Industrials. The housing slump and subprime debacle is far from over, the manufacturing sector is slowing, non-residential construction spending looks as if it's headed lower over the coming months, and consumer spending will likely decline significantly in the months ahead.
Plus, even if the Fed were to try to stimulate economic growth by continuing to lower interest rates, my research strongly indicates it will be unsuccessful in preventing an economic slowdown. Much worse, further rate hikes would only add to already significant inflationary pressures.
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