Service Companies Outpace Factories, Sustaining U.S. Economy

  • Eleven of 18 non-manufacturing industries show growth
  • Gap between services, factory indexes largest since 2001

American service companies continued to outperform their manufacturing counterparts in December as orders and employment picked up, indicating the world’s largest economy will keep expanding this year.

The Institute for Supply Management’s non-manufacturing index, which covers almost 90 percent of the economy, came in at 55.3 last month, with readings greater than 50 signaling growth. While the level is down from November’s 55.9 and the weakest since April 2014, the drop was caused by a plunge in the deliveries component that indicates suppliers had fewer order backlogs to process.

The gap between the Tempe, Arizona-based ISM’s services and manufacturing gauges has averaged almost eight points over the past six months, the widest over a similar period since 2001. The disparity signals retail, construction and health care are among the industries less affected by the slowdown in global demand and surge in the value of the dollar that have hurt U.S. factories.

“The domestic economy is still chugging along, but the rest of the world is weighing on things,” said Scott Brown, chief economist at Raymond James Financial Inc. in St. Petersburg, Florida, whose projection was among the closest in the Bloomberg survey. “Job growth has been very helpful for the consumer sector, but we do expect the pace of job growth to slow as the labor market tightens.”

The median forecast in a Bloomberg survey of 71 economists called for a December reading of 56, with estimates ranging from 54 to 57.5. The measure averaged 57.1 in 2015, up from 56.3 in the previous year and the best annual performance in a decade.

Services Globally

The U.S. reading was at odds with other services measures overseas. A private Chinese services gauge slumped to its second-lowest reading since the series began a decade ago, according to the report from Caixin Media and Markit Economics Wednesday. Confidence among U.K. services firms dropped to a three-year low last month, Markit Economics data also showed.

On a more positive note, a combined manufacturing and services gauge in the euro area unexpectedly rose to 54.3 in December from 54.2 the prior month, the London-based Purchasing Managers’ Index said Wednesday.

The ISM new orders gauge in the U.S. climbed in December to 58.2 from 57.5 the prior month, while a measure of services employment increased to 55.7 from 55.

The business activity index, which parallels the ISM’s factory production gauge, advanced to 58.7 last month from 58.2 in November. A measure of prices paid declined to 49.7, indicating costs were easing, from 50.3.

Deliveries Quicken

The drop in the headline figure was due to a slump in the supplier deliveries gauge, which measures how quickly companies are able to fill orders. That index slumped to a three-year low of 48.5 from 53 the prior month. Readings below 50 mean delivery times quickened.

The ISM services survey covers an array of industries, including retail, health care, agriculture and construction.

Steady job gains last year helped drive domestic demand. A jobs report due Friday from the Labor Department is projected to show employment made further strides in December. Economists are predicting payrolls climbed by about 200,000 last month after a 211,000 increase in November.

At the same time, weaker overseas economies, a stronger dollar and an inventory build in the first half of 2015 continue to dog the nation’s factories.

Factory Slump

The supply management group’s survey of factories earlier this week showed manufacturing contracted in December at the fastest pace in more than six years. The gauge dropped to 48.2, the lowest level since June 2009, from 48.6 in November.

Goods producers worldwide are bogged down. Factories in China contracted in December for a fifth consecutive month as the world’s second-largest economy is poised to grow in 2016 at the slowest pace since 1990. In the U.K., manufacturing unexpectedly cooled in December, suggesting it made little contribution to the economy in the final quarter of 2015.

The spread between the two ISM gauges averaged 7.6 points in the second half of 2015. The last time the gap was larger, in the six months ended in June 2001, when factories were hobbled by the crash in the information technology industry that prompted firms to scrap investment.

Economists at Bloomberg Intelligence, however, say the slowdown in manufacturing should not be ignored because factory output is at least as good a gauge as services of current economic growth.

Divergence Alarming

Whenever the divergence between the ISM manufacturing and services indexes is this large, the non-factory measure trends to drop, according to an analysis by chief economist Carl Riccadonna. What’s more, when such a large divergence occurs outside of recessions, like it is now, the drop in the services gauge is about five points over the next six months, he said.

Federal Reserve policy makers are gauging momentum across U.S. industries to help determine the timing of further changes to the benchmark interest rate. A quarter-percent increase in December marked the first rise since 2006.

(Updates with economist comment in fourth paragraph.)

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