Talk of a U.S. economic slowdown and perhaps even a recession has shaken up the international markets for the last week. But the latest reports from the Institute for Supply Management, known as the ISM, should ease this concern. Last week's ISM report on the manufacturing side showed solid gains that lower the risk the sector itself will fall into recession. Monday's ISM report on the non-manufacturing side did show slower growth in the headline index but new orders were solid and firmly in line with trend pointing to moderate and consistent growth ahead. Both reports are in line with the Federal Reserve's efforts to slow the economy to a non-inflationary sustainable pace. Nothing really to come apart about.

This report will focus on the ISM's inventory readings which indicate that the nation's purchasers, at the front line of an economic slowdown, are successfully managing their supplies to match demand. The manufacturing reports are issued on the first business day of the following month and January's report (released on February 1), showed one of the sharpest month-to-month inventory contractions in the 59-year history of the report -- an 8.6 percentage point swing to 39.9. The reading was soon confirmed by the ISM's non-manufacturing report (issued on each month's third business day) which showed a 6.5 point fall in January inventories to 47.0, the first sub-50 reading in two years and the third sharpest downswing in this report's 10-year history.

The graph below tracks the ISM's manufacturing inventory index over the past three recessions: 1981-2, 1990-91, and 2001. Each time this index hit its low during -- not in advance of the recession. This suggests that supply managers at the time were taken by surprise, adjusting their inventories in reaction to -- not always in anticipation of -- declining demand. And bloated inventories deepen a recession, as firms have to cut back production and sack workers to realign supply with demand. The latest reading suggests that supply managers are thinking ahead, adjusting their inventories before it's too late. Still, tracking the gridline at the 40-level in the graph shows how rare and potentially unsettling January's reading was. February's inventory index, issued late last week, popped up to 44.6.

A quick note on what the ISM inventory index means: sub-50 readings indicate that a greater share of the sample's respondents are reporting a month-to-month decline in their own inventories than those reporting a month-to-month rise. The greatest portion typically reports no month-to-month change. The ISM's sample consists of purchasing executives -- that is leading supply managers at U.S. firms asked specifically to respond to U.S. conditions only. Firms in the sample are selected by their industry and its relative contribution to GDP, whether on the goods-producing side for the manufacturing report or the service-providing side for the non-manufacturing report with the latter including the grayer areas of mining, utilities and construction. Sample size for any one report is large enough at 250.

There was another big concern with the December manufacturing report. The new orders index, the report's leading index pointing to future business activity, fell below the inventory index, at least initially before annual revisions reversed the inversion to only a close call. An inversion suggests that orders slowed so fast that supply managers were unable to adjust inventories downward. The graph below shows how rare inversions or close calls are, with two of them hitting during recessions.

It's been my pleasure for about 10 years to conduct monthly interviews, on behalf of Market News International, with the ISM survey chiefs. Norbert Ore, head of the ISM manufacturing side, always stresses how uncomfortable manufacturing purchasers get when inventories suddenly rise relative to orders. Supply managers want to keep a nice gap between orders and inventories, seen in the graph's white space between the red of inventories and the blue of orders. Inventories are expensive to hold and present a risk should demand, or availability of supply, suddenly shrink. Movement in the last two months has been very promising, showing that supply managers have cut back inventories at the same time that orders have improved. Ore is upbeat on the outlook for the manufacturing sector, hopeful that conditions have steadied and are poised in the months ahead to begin an incremental climb -- right in line with the soft landing.

The ISM manufacturing report also has a customer inventory index. This is a newer index with 11 years of history that centers on respondents' subjective view of inventory levels at their customer firms. Since one's customer is also another's supplier, the index tracks sentiment through the manufacturing supply chain. As the graph below shows in red, the index has been steadily climbing from mid-2006 to the latest report in February and now stands at a six-year high. This means that purchasers think other firms are heavy with inventory. By the way I chose red in the graphs to identify inventory, reflecting supply managers' sensitivity to the topic. The graph below shows one of the effects when inventories are too high, that is lower prices.

Inventories are less of a hot button for purchasers on the non-manufacturing side. Here lead times are much shorter. As ISM non-manufacturing chief Anthony Nieves explains, providing services is much less goods-intensive and far less time consuming than producing an aircraft. Here just-in-time inventory is the only game in town as supply managers keep only enough on hand to keep costs down while at the same time ensuring continuity of supply. Even in the construction sector where building can take several months, Nieves says lead times are much shorter than on the manufacturing side. Lead times on the manufacturing side, in fact, often span years. But the graph below does show that inventories for both groups move roughly together. Supply managers across the economy were reporting month-to-month inventory declines a little bit into and during the 2001 recession. Inventories then gradually rose through the expansion until the jolt at the beginning of this year, shown in both sectors.

The bottom line
The ISM reports also offer data on the availability of goods and labor. These lists, known as short-supply lists, are thankfully very short right now and are a big plus for the economic outlook, indicating that supply managers have the freedom to work down supply without sweating over continuity of supply and that they can get what they need if and when they need it. Another big plus is an absence of significant shipping delays with the supplier delivery indexes of both reports tame. This is no surprise given easing demand and a lack of shipping disruptions such as 2005's hurricanes for instance. Also many freight companies are complaining that business has definitely fallen off, bad for the share prices of such companies but good for delivery times. Sufficient supply and smooth delivery point to stable prices and an orderly adjustment for inventories. Each month the ISM reports offer the first look at the nation-wide supply chain, which right now is pointing to orderly economic moderation.