Final Capitulation Resumes...

No surprises today as the Dow turned down, resuming its bear trend as expected. Investors were hit with the worst ISM index reading since 1981 today, pointing towards continued economic contraction in the months ahead. So, what exactly is this ISM index and what makes it such a closely watched economic indicator?

ISM stands for Institute for Supply Management. It is an Arizona based group representing purchase managers around the country. It conducts 2 main surveys; the Manufactoring Survey and the Non-manufactoring Business survey. The former is what we refer to as the ISM Index and the latter, the ISM Services Index. What they do is really very simple. They survey purchasing managers in the manufactoring sector monthly in order to arrive at the ISM index. How is it that the opinions of these purchasing managers is such an important economic indicator? The logic is extremely simple as well. When the economy picks up, manufactoring activities pick up and in order for manufactoring to pick up, purchasing managers need to purchase factors of production! :) In fact, the index is important for 2 main reasons. Firstly, it is the first economic number released every single month. This gives investors the first look at what to expect in the numbers for the month ahead. Secondly, the ISM index has produced an amazing correlation with real GDP! In fact, a reading of 50 has been shown to correlate with a real GDP growth of about 2.5% with an additional 0.3% growth every point above 50. In fact, the Feds also watch this number in order to eventually arrive at a rate decision.

So, the Dow is going to go down lower throughout the week, no doubt about that. This is definitely going to be a negative week with support at around 7200. That is when it will start to get tricky. This Friday's Job report (see economic calendar) could get tricky as well. It is definitely going to be a multi-year high unemployment number again but how will investors construe it? Will it be construed as the peak unemployment that everyone's been waiting for, spurring a reversal? Seriously, odds are good if the 7200 support level holds.