June 1 (Bloomberg) -- Manufacturing in the U.S. shrank less than forecast in May as new orders increased for the first time since the recession began, a sign that companies are growing more confident the slump will end this year.

The Institute for Supply Management’s factory index rose to 42.8 from 40.1 in April. Readings of less than 50 on the Tempe, Arizona-based group’s gauge signal a contraction. The new-orders measure jumped to 51.1 from 47.2.

More companies are recovering from the cuts in output and payrolls that came after Lehman Brothers Holdings Inc.’s collapse last September deepened the economic downturn. Still, the bankruptcies of automakers Chrysler LLC and General Motors Corp. may ripple through the economy, increasing unemployment and tempering any growth rebound later this year.

“The downsizing is getting near to an end as sales and production are getting closer to alignment,” said Stuart Hoffman, chief economist at PNC Financial Services Group Inc. in Pittsburgh. “These numbers are telling us the end of the recession is finally in sight.”

Economists expected the ISM’s manufacturing index to rise to 42.3, according to the median of 71 projections in a Bloomberg News survey. Estimates ranged from 38 to 45.5.

The ISM’s production index rose to 46, the highest since August, from 40.4 the prior month. The employment index slipped to 34.3 from 34.4. A gauge of export orders rose to 48 from 44.

Prices Paid

The index of prices paid jumped to 43.5 from 32. Economists had projected that the measure, which averaged 66.5 last year, would rise to 35.

The supplier delivery gauge, a measure of the time it takes to receive goods, increased to 49.8 from 44.9 the prior month. The measure of orders waiting to be filled rose to 48 from 40.5.

The inventory index fell to 32.9 from 33.6. A figure below 50 means manufacturers are reducing stockpiles.

The economy shrank less than previously estimated in the first quarter, the government said last week, and a Reuters/University of Michigan index showed confidence among consumers rose in May to the highest level since September. Still, a gauge of current conditions, which reflects whether Americans are likely to buy big-ticket items such as cars, fell.

Stocks have surged and Treasuries have dropped as investors bet the worst of the downturn has passed. The Standard & Poor’s 500 Index gained 2.4 percent to 941.10 at 10:37 a.m. in New York. Yields on benchmark 10-year notes climbed to 3.63 percent from 3.46 percent at the end of last week.

Personal Spending

The Commerce Department said today that personal spending fell in April for a second straight month, dipping 0.1 percent, as rising unemployment and record wealth destruction prompted households to boost savings rates to the highest level in 14 years. Incomes climbed 0.5 percent, reflecting increases in unemployment insurance benefits and Social Security payments associated with the Obama administration’s stimulus plan.

Spending on construction projects in the U.S. unexpectedly rose in April, gaining the most since August, as the housing slump eased and more commercial projects got underway, according to another report today from Commerce.

The ISM report reinforces regional data showing the factory industry’s contraction slowed in May. The Federal Reserve Bank of New York’s manufacturing gauge rose to the highest level since August, the Philadelphia Fed’s measure jumped to an eight- month high and the Richmond Fed’s index showed the first expansion in more than a year.

Auto Bankruptcies

By contrast, the Institute for Supply Management-Chicago Inc.’s gauge of business activity shrank at a faster pace than anticipated. Part of the drop may have resulted from the auto slump in neighboring Detroit, economists said.

More pain for some factories and workers is ahead. GM, the world’s largest carmaker until its 77-year reign ended last year, filed for bankruptcy protection in the U.S. today. Chrysler filed for bankruptcy on April 30, followed by Visteon Corp., the former parts-making unit of Ford Motor Co., and chassis manufacturer Metaldyne Corp.

The outlook is improving for other companies. Alcoa Inc., the largest U.S. aluminum producer, said distributors of the lightweight metal are showing renewed buying interest after seeing signs that demand will revive.

Metal distributors have “seen some green shoots” and are concerned they won’t be able to cover orders once demand returns because their inventories are near zero, Alcoa Chief Executive Officer Klaus Kleinfeld said May 29 in New York.

“The distribution chain will generate this giant sucking sound of demand,” Kleinfeld said.

To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net

Last Updated: June 1, 2009 10:51 EDT