July 1 (Bloomberg) -- Manufacturing in the U.S. shrank at the slowest pace since August 2008 and pending sales of existing homes advanced for a fourth month, underscoring signs the economy began to stabilize in the second quarter.

The Institute for Supply Management’s factory index rose in June for a sixth straight month, to 44.8; readings less than 50 signal contraction. The National Association of Realtors said the number of Americans signing contracts for existing homes increased 0.1 percent in May after a 7.1 percent gain.

“We’re going to see a temporary substantial improvement” in the economy, said Martin Feldstein, the Harvard University economist and former Reagan administration adviser who is a member of the U.S. recession-dating panel. “It’s a bounce that is coming from the beginning of the fiscal stimulus,” he said in an interview with Bloomberg Radio.

Still, Feldstein warned that the economy will be “going down again” into 2010. Underscoring that danger was a survey issued today by ADP Employer Services that showed U.S. companies eliminated 473,000 jobs in June after a 485,000 drop the previous month. The report also foreshadowed a jump in the unemployment rate in tomorrow’s Labor Department report that will temper any rebound in consumer spending.

Stocks advanced on optimism the worst of the recession, the deepest in half a century, is over. The Standard & Poor’s 500 Stock Index gained 0.4 percent to 923.33 at 4:16 p.m. in New York. Yields on benchmark 10-year notes were little changed, increasing to 3.544 percent from 3.535 percent late yesterday.

Construction Slump

Spending on construction projects dropped 0.9 percent in May after increasing in April for the first time in seven months, a report from the Commerce Department also showed.

The gain in the ISM factory index was paced by improvements in production, which expanded for the first time since August, and employment. A gauge of export orders also increased, almost reaching the breakeven level of 50.

“Things are starting to look up,” Norbert Ore, chairman of the ISM’s manufacturing survey, said on a conference call with reporters. “With the exception of inventories, which were still hitting a bottom in terms of rate of decline, all of the other indexes have moved in the right direction and should get us to 50 in the next few months.”

One disappointing reading was in new orders, where the index fell to 49.2 from a reading of 51.1 in May that showed the first expansion in bookings in more than a year.

Auto Shutdowns

Bankruptcies at General Motors Corp. and Chrysler LLC have rippled through the auto industry and have also caused some suppliers to file for protection from creditors.

“The next three months are going to be critical,” Tony Brown, purchasing chief for Ford Motor Co., said June 24 in an interview. “The Chapter 11 filings have increased the cash-flow pressure on the supply base.”

Even so, government efforts to revive auto sales may give manufacturing and the economy a boost in the third quarter. The “cash for clunkers” bill that passed Congress in June gives consumers as much as $4,500 to trade in their old cars for more fuel-efficient vehicles.

An increase in auto sales will come as automakers slashed inventories to get rid of unwanted stocks, meaning manufacturers will need to crank up production again to meet the new demand, according to Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York.

Maki last week boosted his forecast for economic growth in the second half of 2009 by half a percentage point to 3 percent.

Crisis ‘Behind Us’

Other companies are already seeing an improvement.

The period of crisis management at General Electric Co. is “behind us” and some level of economic growth will take place next year, Chief Executive Officer Jeffrey Immelt said earlier this week.

“In some way, shape or form, 2010 and beyond will see economic growth,” Immelt said at the London School of Business on June 29. “How positive it is remains to be seen.”

One reason for concern is mounting unemployment. A Labor Department report tomorrow may show employers cut 363,000 workers from payrolls in June and unemployment rose to a 26-year high of 9.6 percent. Still, following May’s 9.4 percent jobless rate, the increase would be the smallest since November.

The housing market is stabilizing after a collapse in prices, historically low mortgage rates and tax incentives made properties more affordable for Americans. Still, with unemployment forecast to reach 10 percent this year, home purchases may languish at low levels for months before a recovery emerges.

Pending resales are considered a leading indicator because they track contract signings. The National Association of Realtors’ existing-home sales report tallies closings, which typically occur a month or two later.

The agents’ association reported last week that home resales increased 2.4 percent in May, a second consecutive gain that reinforced the case that the slump in home sales may level out this year. The median price dropped 17 percent from a year earlier, the third-biggest decline on record.

To contact the reporters on this story: Courtney Schlisserman in Washington at cschlisserma@bloomberg.net; Bob Willis in Washington bwillis@bloomberg.net.

Last Updated: July 1, 2009 16:42 EDT