Manufacturers are slashing jobs and inventories ahead of the year-end "fiscal cliff," in a fresh sign Monday the sector will keep teetering amid the ongoing policy uncertainty.
The Institute for Supply Management's manufacturing index fell to a three-year low of 49.5 in November from 51.7 in October, a surprise return to below the neutral 50 level after two months of expansion.
The indicator has been under that threshold for four of the last six months. The jobs gauge dropped to 48.4 in Nov. from 52.1, slipping into negative territory for the first time since September 2009. The inventories measure sank to 45 from 50.
This latest slowdown could show up in the Labor Department's November payroll report on Friday. Manufacturers added jobs in October but shed them in the two earlier months.
U.S. stock indexes erased early gains on the ISM data, then closed modestly lower on no signs of a fiscal deal in Washington.
Growth in October durable goods orders suggested demand was holding up despite the fiscal cliff of steep tax hikes and budget cuts. But comments in the ISM report pointed to policy concerns as the source of weakness, with little mention of Superstorm Sandy.
"The fiscal cliff is the big worry right now," said a purchasing manager in the fabricated metals industry. "We will not look toward any type of expansion until this is addressed.
The sharp drop in stockpiles, which had slowed in the two months prior, shows manufacturers don't want to be left with excess inventories in case the economy falters again, said Joel Naroff, chief economist at Naroff Economic Advisors.
Production also picked up despite orders sinking to 50.3 from 54.2, implying firms may have been rushing to fill existing orders and book profits before conditions get worse, he added.
"Businesses can't sit around and wait for sanity to break out in Washington," Naroff said.
Export orders shrank at a faster pace and have been down for six straight months, while manufacturing data in key export markets have started to improve. Imports continued to deteriorate, though at a slower pace.
A final reading on the private sector's gauge of Chinese factory activity confirmed it returned to growth after shrinking for more than a year. A eurozone manufacturing reading is at an eight-month high, albeit still negative.
But even as U.S. manufacturing limps into the new year with the fiscal cliff hanging over it, consumers remain confident and are buying more, including big-ticket items like cars. The loss of vehicles to Sandy has spurred replacement purchases.
Ford said November sales were up 6.5% annually and announced plans to ramp up Q1 production from Q4 levels. GM's sales climbed 3.4%, and Chrysler saw a 14% jump. Toyota surged 17% as it continued to recover from levels affected by last year's earthquake and tsunami.
Americans also are confident enough to buy new homes again and refurbish existing ones, sending construction spending up 1.4% in October from September.
Residential investment rose 3%, the biggest gain since June. On an annual basis, residential spending was up 19.4%.
As homeowners and businesses affected by Sandy start rebuilding more, demand for manufactured goods should rebound too, Naroff said. Some reconstruction will start in the spring, providing another boost then.
ISM's index could slip further in December but may rise in January, and a deal to resolve the fiscal cliff would send it even higher, he predicted.
But a political breakthrough may not be enough to provide a major boost to the economy.
The cliff and Sandy are just a few factors among a number of other head winds, such as Europe's debt crisis, slower China growth, and ObamaCare, said Lawrence Creatura, a portfolio manager at Federated Investors.
"The list is long," he said. "There are a lot of sources of uncertainty to businesses and consumers."